Monday, March 06, 2006
Money Makes Us Crazy
Money Makes Us Crazy: "A fundamental economic principle is that investors are perfectly logical. Since the beginning of time, economic theory has assumed that we process all known information, learn from our mistakes and then make the decision that will maximize 'utility'. Of course, that is a bunch of hooey. We are not robots and we don't react logically. Anyone who has actually ever invested in the stock market knows that.
How we really act and why is the realm of behavioral finance. Here is one example from The Australian:
LATE at night, in a basement laboratory at Stanford University, Brian Knutson made a startling discovery: our brains lust after money, just like they crave sex.
It was May 2004, and Knutson, a professor of neuroscience and psychology at the California university, was sending student volunteers through a high-power imaging machine called an MRI.
Deep inside each subject's head, electrical currents danced through a bundle of neurons about the size and shape of a peanut. Blood was rushing to the brain's pleasure centre as students executed mock stock and bond trades. On Knutson's screen, this region of the brain, the core of human desire, flashed canary yellow.
The pleasure of orgasm, the high from cocaine, the rush of buying Google at $US450 a share - the same neural network governs all three, Knutson, 38, concluded. What's more, our primal pleasure circuits can, and often do, override our seat of reason, the brain's frontal cortex, the professor says. In other words, stocks, like sex, sometimes drive us crazy.
One of the six fundamental principles of the way I invest my own money (and the way I teach others to invest) is that emotions are our worst enemy. Emotions cause us to do the exact opposite of what we should be doing. Emotions cause us to buy when we should be selling and sell when we should be buying.
One of the keys to being a successful investor is to learn how to
1) ignore your emotional response;
2) create a rigid system that keeps you from responding emotionally; or even better
3) train yourself to act opposite to what your emotions would tell you to do.
"
How we really act and why is the realm of behavioral finance. Here is one example from The Australian:
LATE at night, in a basement laboratory at Stanford University, Brian Knutson made a startling discovery: our brains lust after money, just like they crave sex.
It was May 2004, and Knutson, a professor of neuroscience and psychology at the California university, was sending student volunteers through a high-power imaging machine called an MRI.
Deep inside each subject's head, electrical currents danced through a bundle of neurons about the size and shape of a peanut. Blood was rushing to the brain's pleasure centre as students executed mock stock and bond trades. On Knutson's screen, this region of the brain, the core of human desire, flashed canary yellow.
The pleasure of orgasm, the high from cocaine, the rush of buying Google at $US450 a share - the same neural network governs all three, Knutson, 38, concluded. What's more, our primal pleasure circuits can, and often do, override our seat of reason, the brain's frontal cortex, the professor says. In other words, stocks, like sex, sometimes drive us crazy.
One of the six fundamental principles of the way I invest my own money (and the way I teach others to invest) is that emotions are our worst enemy. Emotions cause us to do the exact opposite of what we should be doing. Emotions cause us to buy when we should be selling and sell when we should be buying.
One of the keys to being a successful investor is to learn how to
1) ignore your emotional response;
2) create a rigid system that keeps you from responding emotionally; or even better
3) train yourself to act opposite to what your emotions would tell you to do.
"
