YOUR MONEY and YOUR BRAIN -NEURAL INVESTING/BEHAVIORAL FINANCE Humankind evolved to seek rewards and avoid risks but not to invest wisely. To do that, youll have to outwit your impulses-especially the greedy and fearful ones. by JASON ZWEIG FOR MOST PURPOSES IN DAILY LIFE your brain is a superbly functioning machine, steering you away from danger while guiding you toward basic rewards like food, shelter and love. But that brilliant machine can lead you astray when it comes to investing. You buy high only to sell low. You try to time the market. You follow the crowd. You make the same mistakes again. And again. How come? Were beginningto get answers. Scientists inthe emerg ingfield ofneuroeconomics-ahybridofneuroscience, economics arid psychology-are makingstunningdiscoveries about howthe brain evaluates rewards, sizes up risks and calculates probabilities. With the wonders ofimagingtechnologywe can observe the precise neural circuitrythatswitches on and offin your brain whenyou invest. Those pictures make it clear that your investingbrain often drives you to do things that make no logical sense-but make perfect emo tional sense. Yourbrain developed to improve our species odds of survival. You, like every other human, are wiredto cravewhat looks rewardingand shunwhatseemsrisky. To counteractthese impulses, your brain has only a thin veneer ofmodern, analytical circuits that are often no matchfor the power ofthe ancient parts ofyour mind. And when you win, lose or risk money; you stir up some profound emotions, includinghope, surprise, regret and the two well examine here: greed and fear. Understanding how those feelings-as a matter ofbiology-affectyourdecision-makingwill enableyou to see as never before what makes youtick, and howyou can improve, as an investor. ~ YOUR MONEY AND YOUR BRAIN THE THRILL OF THE CHASE WHY IS IT SO HARD for most of us to learn that the old saying Money doesnt buy happiness is true? After all, we feel as if it should. The answer lies in a cruel irony that has enormous implications for financial behavior: Our brains come equipped with abiological mechanism that is more aroused when we anticipate a profit than when we get one. I lived through the rush of greed in an experiment run by Brian Knutson, a neuroscien tist at Stanford University. Knutson put me into a func tional magnetic resonance imaging (fMRI) scanner to trace mybrain activity while I played a kind ofinvesting video game that he had designed. By combining an enormous magnet and a radio signal, the fMRI scanner pinpoints momentary changes in the level of oxygen as blood ebbs and flows within the brain, enabling researchers to map the neural regions engaged by a particular task. In Knutsons experiment, a display inside the fMRI machine showed me a sequence ofshapes that each signaled a different amount ofmoney: zero ($0), medium ($1) or large ($5). Ifthe symbol was a circle, I could win the dollar amount displayed; ifitwas asquare, I couldlose the amountshown.After each shape came up, between 2 and 21jz seconds would pass-thats the anticipation phase, when I was on tenterhooks waiting for my chance to win or lose-and then a white square would appear for a split second. To win or avoid losing the amount I had been shown, I had to click a button with my finger when thesquare appeared. At thehighestofthe three levels ofdif ficulty, I had less than one-fifth of a second to hit the button. After each try the screen showed how much Id just won or lost and updated my cumulative score. When a shape signaling a small reward or penalty appeared, I clicked placidly and either won or lost. But if a circle marked with the symbols of a big, easy payout came up, I could feel a wave ofexpec tation sweep through me. At that moment, the fMRI scan showed, the neurons in a reflexive, or emotional, part ofmybrain called the nucleus accumbens fired like wild. When Knutson mea sured the activity tracked by the scan, he found that the possibility ofwinning $5 set offtwice as strong a signal in my brain as the chance at gaining $1 did. On the other hand, learn ing the outcome of my actions was no big deal. Whenever I captured the reward, Knutsons scanner found that the neurons in my nucleus accumbens fired much less intensely than they had when I was hoping to get it. Based on the dozens ofpeople Knutson has studied, its highly unlikely that your brain would respond much differently. Whydoes the reflexive partofthe brainmake a bigger deal ofwhatwe mightget than ofwhatwe do get? Thatfunc tionis partofwhatBrianKnutsons mentor, JaakPanksepp ofBowling Green State University in Ohio, calls the seeking system. Over millions ofyears ofevolution, itwas the thrill of anticipation that put our senses in a state ofhigh awareness, Howto Keep from Beating Yourself • AVOID THE SURE THING Your seeking system is especially turned on by the prospect of a big score, and that in turn will hinder your ability to calculate realistic odds for the success of an invest ment. Be on your guard against any sales rep who tries to lure you with jackpot jargon like cant miss, double your money or the skys the limit. • REMEMBER: LIGHTNING SELDOM STRIKES TWICE If youve ever had the taste of a big gain, youll likely be tempted to try to get that feeling back. So be espe cially wary of investing in stocks or mutual funds that remind you of the one you made a killing on long ago; chances are, any similarities to another investment, living or dead, are purely coincidental. • THINKTWICE Making a financial decision while youre inflamed by the prospects of a big gain-or a huge paper loss- is a terrible idea. Calm yourself down (if you dont have kids to distract you, take a walk around the block or go to the gym) and recon sider when the heat of the moment has passed. • GET AWAY FROM THE HERD If you are part of an investment organization, appoint an internal sniper whose job is to shoot down ideas everyone likes. (Rotate this role to prevent one person from becoming universally disliked.) Similarly, if youre at a barbecue and your friends are talking up a seem ingly great opportunity, speak to someone you respect who isnt part of the group before you jump in. bracing us to capture uncertain rewards. Our anticipation circuitry, says Paul Slovic, a psychologist at the University of Oregon, acts as a beacon of incentive that enables us to pursue rewards that canbe earned onlywith patience and commitment. Ifwe derived no pleasure from imagining riches down the road, we would grab only at those gains that loom immediately in front of us. Thus our seeking system functions partly as a blessing and partly as a curse. We pay close attention to the possibil ity of coming rewards, but we also expect that the future will feel better than it does once it turns into the present. Avivid example ofthis is the stock of Celera Genomics Group. In September 1999, Celera began sequencing the human genome. By identi fying each ofthe 3billion molecular pairings that make up human DNA, the company could make one of the biggest leaps in the history ofbiotech nology. Investors went wild with anticipation, driving the stock to a peak of$244 in early 2000. Then, on June 26, Celera announced that it had completed cracking the code. How did the stock react? By tanking. Itdropped 10.2% that day and another 12.7% the next day. Nothing had occurred to change the companys fortunes for the worse. Quite the contrary: Celera had achieved a scientific miracle. So what happened? The likeliest explanation is simply that the anticipation of Celeras success was so intense that reality was a letdown. Getting exactly what they wished for left investors with nothing to look forward to, so they got out and the stock crashed. THE STUFF OF MEMORIES RESEARCHERS IN GERMANY tested whether anticipating a finan cial gain can improve memory. Ateam ofneurologists scanned peoples brains with an £MRI machine while showing them pictures of objects like a hammer or a car. Some images were paired with the chance to win half a euro, while others led to no reward, The participants soon learned which pictures were reliably associated with the prospect ofmaking money, and the scan showed that their anticipation circuits fired furiously when those images appeared. Immediately afterward, the researchers showed the participants a larger set of pictures, including some that had not been displayed inside the scanner. People were highly accurate at distin guishing the pictures they had seen during the experi ment and equally adept at recognizingwhich ofthose pictures had predicted a gain.. Three weeks later the participants came back to the lab, where they were shown the pictures again. This time people could even more readily distinguish the pictures that had signaled a financial gain from those that had not-although they hadnt laid eyes on them in 21 days! Astounded, the researchers went back and re-examined the £MRI scans from three weeks earlier. It turned out that the potentially rewarding pictures had set off more intense activation not only in the anticipation circuits but also in the hippocampus, a part ofthe brain where long-term memories live. Thefire ofexpectation, itseems, somehowsears the memory • LOCK UP YOUR MAD MON EY Put at least 90% of your stock money into a low-cost, diversified index fund that owns everything in the market. Put 10%, tops, at risk on speculative trades. Be sure this mad money resides in a separate account from your long term investments; never mingle them. Never add more money to the speculative account. (Its especially important to resist that temptation when your trades have been doing welL) If you get Wiped out. close out the account. • CONTROL YOUR CUES The stock market generates signals that can goad you into trading. Try watching CNBC with the sound off so that none of the hullabaloo about what the market is doing this second can distract you. If you walk past the local brokerage firm every day so you can sneak a peek at the elec tronic ticker, take a different route. If you obsessively check a stocks price, use the history window on your browser to count how many times youve updated the price that day. The number may shock you. • USE YOUR WORDS While vivid sights and sounds-say, red down arrows and scenes of mayhem on the exchange f1oor fire up your emotions, the more complex cues of language activate analytical areas of your brain. To prevent your feelings from over whelming the facts and leading you to sell in a panic, ask yourself: -7 Other than price, whats changed? -7 Are my original reasons to invest still valid? -7 Shouldnt I like this investment even more now that its cheaper? • TRACK YOUR FEELINGS Many of the worlds best inves tors have learned to treat their own feelings as reverse indicators: Excitement becomes a cue that its time to consider selling; fear tells them they should be thinking about buying. lance asked renowned fund manager Brian Posner of Fidelity and Legg Mason how he sensed whether a stock would be a moneymaker. If it makes me feel like I want to throw up, he answered, I can be pretty sure its a great investment. YOUR MONEY AND YOUR BRAIN of potential rewards more deeply into the brain. The anticipa tion of reward: says neurologist Emrah Diizel, is more impor tant for memory formation than is the receipt ofreward. Anticipation has another unusual neural wrinkle. Brian Knutson has found that while your reflexive brain is highly responsive to variations in the amount ofreward at stake, it is much less sensitive to changes in the probability of receiving a reward. Ifa lottery jackpot was $100 million and the posted odds ofwinning fell from one in 10 million to one in 100 million, would you be 10 times less likely to buy a ticket? Ifyoure like most people, you probably would shrug, say A long shots a long shot and be just as happy buying a ticket as before. Thats because, as econo mist George Loewenstein of Carnegie Mellon University explains, the mental image of$100 million sets offa burst of anticipation in the reflexive regions ofyour brain. Only later will the analytical, or reflective, areas calculate that youre less likely to win than Ozzy Osbourne is to be elected Pope. When possibil ity is in the room, probability goes out the window. Its no different when you buy a stock or a mutual fund: ~ I----------------------- risk isnt that the market will Your expectation ofscoring a reactor at Chernobyl, Ukraine melted down in 1986. Early estimates were thattens ofthousands ofpeople might be killed by radiation poisoning. By 2006, however, fewer than 100 had died. Meanwhile, nearly 8,000 Americans are killed every year by skin cancer, commonly caused by overexposure to the sun. In the typical year, deer are responsible for roughly 130 human fatalities-seven times more than alligators, bears, sharks and snakes combined. Deer, of course, dont attack. Instead, they step in front of cars, causing deadly collisions. None of this means that nuclear radiation is good for you or that rattlesnakes are harmless. What it does mean is that we are often most afraid ofthe least likely dan gers and frequently not wor ried enough about the risks that have the greatest chances of coming home to roost. Were no different when it comes to money. Every investors worst nightmare is a stock market collapse like the crash of1929. According to a recent survey of1,000 inves tors, theres a 51% chance that in any given year, the u.s. stock market might drop by one-third. In fact, the odds that u.s. stocks will lose a third oftheir value in a given year are around 2%. The real big gain elbows aside your ability to evaluate how likely you are to earn it. That means your brain will tend to get you into trou ble whenever youre confronted with an opportunity to buy an investment with a hot-but probably unsustainable-return. * * * * * * * * WHAT ARE YOU AFRAID OF? Here are two questions that might, at first, seem silly. 1 Which is riskier: a nuclear reactor or sunlight? 2 Which animal is responsible for the greatest number of human deaths in the U.S.? o Alligator 0 Deer 0 Snake o Bear 0 Shark Now lets look at the answers. The worst nuclear accident in history occurred when the melt down but that inflation will erode your savings. Yet only 31% ofthe people surveyed were worried that they might run out ofmoney duringtheir first 10 years of retirement. Ifwe were logical we would judge the odds ofa risk by asking how often something bad has actually happened under similar circumstances. Instead, explains psychologist Daniel Kahneman, we tend to judge the probability of an event by the ease with which we can call it to mind. The more recently it occurred or the more vivid our memory ofsomething like it in the past, the more available an event will be in our minds .and the more probable its recurrence will seem. THE HOT BUTTON OF THE BRAIN DEEP IN THE CENTER OF YOUR BRAIN, level withthe top ofyour ears, lies a small, almond-shaped knob oftissue called the amygdala (ah-mig-dah-lah). When you confront a potential risk, this part ofyour reflexive brain acts as an alarm system shooting signals up to the reflective brain like warning flares. (There are two amygdalas, one on each side ofyour brain.) 108 September The result is that a moment ofpanic can wreak havoc on your investing strategy. Because the amygdala is so attuned to big changes, a sudden drop in the market tends to be more upsettingthana longer, slower decline, even ifits greater in total. On Oct. 19, 1987, the U.S. stock market plunged 23%-a deeper one-day drop than the crash of 29. Big, sudden and inexplicable, the 87 crash was exactly the kind ofevent that sparks the amygdala. The memory was hard to shake: In 1988, U.S. investors sold $15 billion more worth ofshares in stock mutual funds than they bought, and their net purchases of stock funds didnt recover to pre-crash levels until 1991. One bad Monday disrupted the behavior of mil lions ofpeople for years. There was something more at work here than merely investors individual fears. Anyone who has ever been a teenager knows that peer pres sure can make you do things as part of a group that you might never do on your own. But do you make a conscious choice to conform or does the herd exert an automatic, almost magnetic, force? People were recently asked to judge whether three-dimen sional objects were the same FRIGHT MAKES RIGHT I LEARNED HOW MY OWN AMYGDALA REACTS TO RISK when I participated in an experiment at the University ofIowa. First I was wired up with electrodes and other monitoring devices to track my breathing, heartbeat, perspiration and muscle activity. Then I played a computer game designed by neurolo or different. Sometimes the s:======================= FEAR by James Victore folks being tested made these choices in isolation. Other times they first saw the responses of four peers (whowere, infact, colludingwiththe researcher). When people made their own choices, they were right 84% ofthe time. When the peer group all made the wrong choice, however, the individuals being tested chose correctly just 59% of the time. Brain scans showed that when the subjects fol lowed the peer group, activation in parts oftheir frontal cortex decreased, as if social pressure was somehow overpowering the reflective, or analytical, brain. When people did buck the consensus, brain scans found intense firing in the amygdala. Neuroscientist Gregory Berns, who led the study, calls this flare-up a sign ofthe emotional load associated with standing up for ones belief. Social isola tion activates some ofthe same areas in the brain that are trig gered by physical pain. In short, you go alongwith the herd not because you want to but because it hurts not to. Being part of a large group of investors can make you feel safer when every thing is going great. But once risk rears its ugly head, theres no safety in numbers. ,I] gists Antoine Bechara and Antonio Damasio. Starting with $2,000 in play money, I clicked a mouse to select a cardfrom one offour decks displayed on the monitor in front ofme. Each draw of a card made me either richer or poorer! I soon learned that the two left decks were more likely to produce big gains but even bigger losses, while the two right decks blended more frequent but smaller gains with a lower chance ofbiglosses. Gradually I began picking most ofmy cards from the decks on the right; by the end ofthe experimentI had drawn 24 cards in a row from those safer decks. Afterward I looked over the printout that traced my spiking heartbeat and pant ing breath as the red alert of risk swept through my body, even though I didnt recall ever feeling nervous. Early on, when I drew a card that lost me $1,140, my pulse rate shot from 75 to 145. After a few more bad losses from the risky decks, my body would start reactingevenbefore I selected a card fromone ofthem. Merely moving the cursor over the risky decks was enough to make my physiological functions go haywire. My decisions, it turns out, had been driven by fear even though the thinking part ofmy mind had no idea I was afraid. Ironically-and thankfully-this highly emotional part of our brain can actually help us act more rationally. When Bechara and Damasio run their card-picking game with people whose amygdalas have been injured, the subjects never learn to avoid choosing from the riskier decks. Iftold that they have just lost money, their body doesnt react; they can no longer feel a finan cialloss. Withoutthesavinggrace offear, the analytical parts ofthe brain will keep trying to beat the odds, with disastrous results. The process of deciding advantageously: concludes Damasio, is not just logical but also emotional! A trend is established once the market has formed three or four consecutive legs, e.g. for a bull trend, higher highs and higher lows. The higher highs, higher lows, lower highs and lower lows can only be identified after the next bar has closed. Identifying it before the close of the bar risks that the market will act contrary to expectations, move beyond the price of the potential higher/lower bar and leave the trader aware only that the supposed turning point was an illusion.In-between trend line break-outs or swing highs and swing lows, price action traders watch for signs of strength in potential trends that are developing, which in the stock market index futures are with-trend gaps, discernible swings, large counter-trend bars (counter-intuitively), an absence of significant trend channel line overshoots, a lack of climax bars, few profitable counter-trend trades, small pull-backs, sideways corrections after trend line breaks, no consecutive sequence of closes on the wrong side of the moving average, shaved with-trend bars.
Posted on: Fri, 29 Aug 2014 04:41:48 +0000
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