Profiting From Stock Trading
Profiting from Manias and Crashes
The analysis suggests that we are in the midst of a new sort of bubble. While stocks, bonds, and real estate do not appear to be in bubble mode individually, the bubble may be in risk- taking itself. A generation of reward for taking financial risk has pushed us to take too many costly gambles.
The conclusion is that most people should reduce their level of financial risk. Our lizard brains have extrap olated from a golden generation that rewarded risk, and pushed us toward the risky investments that worked so well for so long. Unless productivity from the information revolution saves us, these risky investments are likely to disappoint.
Thus, the prescription is to reduce financial risk in order to be prepared for future opportunities. This advice is, of course, tempered and customized by individual circumstance and tastes.
If humans were the rational, cool-headed robots of economic theory, then achieving our financial goals would be easy. Because we are exactly the opposite—emotional beings subject to bouts of irrational moods and crazy decisions—financial success is difficult. In particular, in several keys areas we need to lean into our human nature in order to profit from financial opportunity.
Four Keys to Profiting from Mean Markets
1. Be Different
A key to making money is to buy when others are selling and sell when others are buying. In other words, in order to make money we have to do the unpopular behavior that others aren't doing.
Running against the mob is difficult because we are built to want to do what others are doing—we want to be part of the group. One study found that social isolation creates pain. In the study, three people played a ball- tossing game on a computer screen while one sits inside a brain scanner. The person in the brain scanner is told that the two other players are real people, but they are actually fake people controlled by the experimenter.
The experiment looked at the brain in two conditions, being part of the group or being ostracized. In the first, the real person is part of the game and gets the virtual ball frequently. In the second, the two artificial players exclude the real person by passing the ball back and forth.
Social isolation produced pain in these people. In fact, the brain scan revealed the same electrical pattern as physical pain. 6 So when we act dif ferently from others we have to overcome our human desire to be part of the group.
This same study showed another interesting pattern. Those people who employed their cognitive abilities more, felt less pain. To be precise, the people who had higher levels of brain activation in the prefrontal cor tex had lower levels of activation in the pain centers. As is one of the main themes of this book, success requires using cognition to control the lizard brain.
2. Make the Investment Moves That Do Not Produce Dopamine
Another key to making money is buying investments that have not done well and selling those that have done well. As humans, we still share the "do-it-again" brain centers with other animals. As B.F. Skinner made famous, animals, including humans, tend to repeat behaviors that were
rewarded. Thus, Skinner's stimulus-response system leads us to love the investments that have made us money and hate the investments that have lost us money.
Our brains are actually bathed in pleasure-causing dopamine when we take the actions that have worked before. Spencer Johnson and Kenneth Blanchard captured the essence of this in their bestseller Who Moved My Cheese? In a world without change, the best way to find cheese is to return to the location where it was found previously. In a world with change, however, the best way to find cheese is to look somewhere new.
Financial markets are the worst environments in which to use stimulus-response processes. Precisely because most people fall in love with past winners, they tend to buy the investments that have gone up, not the ones that will go up. Thus, to make the correct financial decisions, we need to do exactly the opposite of what has been giving us our emotional reward. To make money, we need to break the dopamine addiction (at least in this area of our lives), and use our cognitive ability to control our neration.
Those who want to follow the advice to reduce financial risk will have to do precisely the opposite of what has worked well for a generation.
