The Investor and Market Fluctuations

This article is from Intelligent Investor. Chapter 8: The Investor and Market Fluctuations. I have made some small modifications to it. This explains why we tend to buy when the stocks are going up and sell when the market is going down.(Graham suggests in his book buy stocks when they are reasonable priced irrespective of if the market fluctuations). This also explains why we fixate on the raw magniture of a market decline and forget to put the loss in proportion.

Our money and our brain:

Why does 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 show 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" the next roll of the dice will be even, that a baseball/cricket player is due for a homerun/sixer. that the next winning number in the lottery will definetly be 4-27-9-16-1 and the this hot little stock is the next microsoft.

Groundbreaking new reserach in neuroscience shows that our brains are designed to perceived 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 cingulate and nucleus accumbers automatically anticipate that it will happen again. If it does reapeat, a natural cheminca called dopamine is released, flooding our brain with a soft euphoria. Thus, if a stock goes up an few times in a row, we reflexively expect it to keep going-and your brain chemistry changes as the stock rises, giving us a "natural high". We effecively become addicted to your own predictions.

But when stocks drop, that financial loss fires up our amygdala the part of the brain that processes fear and anxiety and generates the famours "fight or flight" response tht is common to all conrered animals. Just as we can't keep our heart rate from rising if a fire alarm goes off, just as we can't avoid flinching if a rattlesnake slithers onto our hiking path, we can't help feeling fearful when stock prices are plunging.

In fact, the brillian psychologists Daniesl Kahneman and Amos Tversky have show that the pain of financial loss is more than twice as intense as the pleasure of an equivalent gain. Making 1,000 bucks on a stock fells great, but a 1,000 bucks loss wields an emotional wallop more than twice as powerful. Losing money is so painful that many people, terrifed at the prospect of any further loss, sell our near the bottom of refuse to buy more.