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Trading Wisdom 5/22/05

Your Rat Brain Is Out To Get You

Trading Wisdom

May 22, 2005

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 as regards our brain structure.

In the simplest of terms, we have two brains- and 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 feel danger, run in quickly when things seems 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 thinking, 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. 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 and then and so on and so forth until we are literally out of our minds with 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 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 made 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 done this? Panicked out of a position only to see it turn around without 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 nonexuberance. This is why most traders buy high and sell low. Their 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, understand and try to be with yourself 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 come in tune with your feelings. 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.

 

Janice Dorn, M.D. Ph.D.
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Janice Dorn, MD, PhD - Biographical Sketch

Janice Dorn, MD, PhD is a graduate of the Albert Einstein College of Medicine where she received her PhD in Neuroanatomy. She did her postdoctoral work in Neurophysiology at the New York Medical College. She received her MD from La Universidad Autónoma de Ciudad Juárez, did one year of clinical clerkships in Phoenix, Arizona and then completed a Neurology Internship at The University of New Mexico in Albuquerque She is also a graduate of Coach University. She trained in Anesthesiology at UCLA where she also did a Fellowship in Cancer Pain Management. She completed a Psychiatric Residency at the Maricopa Medical Center in Phoenix. She has been a faculty member to the rank of Associate Professor at The University of Texas Southwestern Medical Center at Dallas, The University of Missouri Medical Center at Columbia and the Chicago Medical School. She also held the position of Director, International Clinical Research for a major pharmaceutical company, in which capacity she traveled internationally for nine years. Dr. Dorn began a private boutique practice of Biological Psychiatry in Phoenix, Arizona in 1987.

She holds the following board certifications:

Diplomate, General Psychiatry, American Board of Psychiatry and Neurology; Diplomate, Addiction Psychiatry, American Board of Psychiatry and Neurology; Diplomate, American Society of Addiction Medicine

In recent years, Janice has turned her attention to trading, mentoring and commentary in the financial markets, with emphasis on Behavioral Finance, Mass Psychology and Trading Psychology. She is the author of over 70 publications, including 30 online publications relating to the financial markets.

 

 

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