Your Money and Your Brain
Investment Research for Online Investors

by Benjamin Graham

I am reading Benjamin Graham’s ‘Intelligent Investor’.  I was reminded of my discussion of your ‘Rat Brain’, and how it affects your judgement. This excerpt follows a discussion of reacting to financial news, which can cause anxiety. I would like to share with you a passage from page 220.

Benjamin Graham

“Why do investors find Mr. Market so seductive?    It turns out that our brains are hardwired to get us into investing trouble; humans are pattern-seeking animals.   Psychologists have shown that if you present people with a random sequence-and tell them that it’s unpredictable-they will nevertheless insist on trying to guess what’s coming next.   Likewise, we “know” that the next roll of the dice will be a seven, that a baseball player is due for a base hit, that the next winning number in the Powerball Lottery will definitely be 4-27-9-16-42-10-and that this hot little stock is the next Microsoft. 

Groundbreaking new research in neuroscience shows that our brains are designed to perceive trends even where they might not exist.  After an event occurs just two or three times in a row, regions of the human brain called the anterior cingulated and nucleus accumbens automatically anticipate that it will happen again.  If it does repeat, a natural chemical called dopamine is released, flooding your brain with a soft euphoria.  Thus, if a stock goes up a few times in a row, you reflexively expect it to keep going-and your brain chemistry changes as the stock rises, giving you a “natural high.”  You effectively become addicted to your own predictions.”

“When stocks drop, that financial loss fires up your amygdale-the part of the brain that processes fear and anxiety and generates the famous “fight or flight” response that is common to all cornered animals.   Just as you can’t keep our heart rate from rising if a fire alarm goes off, just as you can’t avoid flinching if a rattlesnake slithers onto your hiking path, you can’t help feeling fearful when stock prices are plunging. 

In fact, the brilliant psychologists Daniel Kahneman and Amos Tversky have shown that the pain of financial loss is more than twice as intense as the pleasure of an equivalent gain.   Making $1,000 on a stock feels great-but a $1000 loss wields and emotional wallop more than twice as powerful.    Losing money is so painful that many people, terrified at the prospect of any further loss, sell out near the bottom or refuse to buy more. 

That helps explain why we fixate on the raw magnitude of a market decline and forget to put the loss in proportion. So, if a TV reporter hollers, “The market is plunging- the Dow is down 100 points!” most people instinctively shudder. But, at the Dow’s recent level of 8,000, that’s a drop of just 1.2%. Now think how ridiculous if would sound if, on a day when it’s 81 degrees outside, the TV weatherman shrieked, “The temperature is plunging, it’s dropped from 81 to 80 degrees!” That, is a 1.2% drop.”

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