People
are neurotic and the markets, since they are large
collections of people, are also neurotic.
We are
neurotic because we are in constant conflict with ourselves,
specifically in regard to our brain structure.
In the
simplest of terms, we have two brains: an old brain and a
new brain. The old brain is primitive, lies deep within the
new brain and has been around for at least 100,000 years.
This is the “rat brain” or limbic area (colored brain areas
in the diagram) that subserves emotion and instinct and
caused our ancestors to run up a tree when the grass started
to move just in case there might be a lion lurking around
somewhere.
This is
our emotional, greedy, needy, old rat brain which is
constantly telling us "Yes, Yes, Yes! Eat more, drink more,
have more sex, take lots of risk, grab for all the gusto you
can get, run away quickly when you are threatened or if you
sense danger, run in quickly when things seem so wonderful,
and, above all, DO NOT THINK!” The rat brain is irrational.
As the
human brain evolved, the old rat brain became encased in and
covered over by the new brain, called the neocortex (the
large beige brain areas in the diagram). This is the new way
of thinking; the analytical, calculating, rational brain.
Every time the rat brain says "Yes, yes, yes!" the rational
brain says "No, no, no! Don't do that, because it is
dangerous, makes no sense, is self-destructive, is not in
the best interests of you or your family or society, is not
smart, could cause you damage, is illogical.” The new brain
is rational. The old brain has been around for at least
100,000 years, but the markets have existed for about 200
years. The new brain has a lot of catching up to do in order
to make us consistently successful in the markets!
All day, and even in sleep, we are waging a war within our
brain. We think, “Oh, yes! I would love to do this or
that, BUT I really shouldn't, because it might not be
good for me or it would hurt me or hurt someone else. But-
hey- what harm could it really do? Could I get away with it?
Yes, Yes… I could. No, No...I really couldn't and shouldn't
and I won't. But- it maybe I could do it a little,
and see …” So it goes on and on, back and forth, until we
feel completely overwhelmed by conflict.
No wonder
there is so much anxiety and depression in the world today
and that at least one person you know (maybe that person is
you) is on psychotropic medications and/or seeing a
“shrink.”
OK, Dr.
Janice....enough of this theory. So what if I am on drugs
for depression and anxiety, or in therapy, or thinking about
it, or feeling like I am losing it? What does this have to
do with me and the markets and making money?
EVERYTHING! Really more than everything since we know so
little right now, and are just starting to see advances in
the burgeoning areas of psychoneuroeconomics and
behavioral/genetic finance.
We are “hardwired” to make bad financial decisions because
of our limbic rat brain. The rat brain is not capable of
evaluating risks and projecting them into the future. It
reacts immediately, instinctually and without thought.
Inexperienced traders (and even some of the most
experienced), when faced with a conflict between rationality
and emotions, will act on emotions. The old rat brain wins
the battle, and it wins over and over again.
Aversion
to loss, which is a disproportionate fear of risk, makes a
lot of sense from an evolutionary standpoint when we were in
the jungle running from wild animals, but makes no sense
whatsoever in the markets. When we see a stock or future
position falling, our brain (and body, but that is another
topic altogether) reacts as if we are being threatened.
Dumping a position when you see it falling is like running
up a tree because you THINK a lion might be lurking. Running
up a tree won't hurt you, but dumping a position on emotion
can wipe you out. That is panic selling.
How often
have you panicked out of a position, only to see it turn
around within minutes to days? That is your rat brain in
charge and your logical brain completely taken over by
emotion.
It also
works the other way. When you see a stock going up and up
every day, the rat brain tells you that it will continue to
go up, and you better get in now because you are missing
out. This is panic buying. You get in and the stock starts
to fall so you panic out of it as well.
The rat
brain loves heuristics. These are mental shortcuts which
link past patterns to potential rewards or losses. Such is
the case with irrational exuberance, and irrational lack of
exuberance. This is why most traders buy high and sell low.
The rat brain takes over, and they are powerless against it.
The rat brain wants results NOW. The new brain is patient,
and waits and analyzes.
Our goal
on the path to becoming successful traders is to understand
ourselves deeply, intimately, and on a minute-to- minute
basis when we are in the midst of making financial
decisions. This is among the most challenging tasks you will
ever be asked to do, and it will take time, patience and the
ability to be rigorously honest with yourself.
I will
give some practical steps to facilitate this process in
future Trading Wisdoms.
For now,
try to better understand yourself: Try being alone in a calm
and centered space during the trading day. Try to tune out
the noise and constant barrage of information. Pay very
close attention to yourself, and try to become in tune with
your feelings. Sometimes you will feel greedy when you
should be feeling fearful, and fearful when you should be
feeling greedy. This is your rat brain playing tricks on
you, and fighting with the logical rational side of you that
is able to sit back, analyze and realize that that the
waving grass may not be a lion to fear, but an omen that
something wonderful is coming your way.
Until next time,
Good Trading and Brain On!
Janice Dorn, M.D., Ph.D
Prescriptions for Profits
www.thetradingdoctor.com
