Risk and Reward: The Psychology of Playing the Markets
Risk and Reward: The Psychology of Playing the Markets by T. Rynne for The Daily Coin
There’s a certain school of thought that dictates that playing the financial markets isn’t done by rational people; in fact, if you’re fond of old Wall Street wisdom, the stock market is governed almost entirely by investors’ fear and greed, a statement made manifest by the Chicago Board Option Exchange’s Volatility Index, a measure of stock volatility (currently at an all-time low) and otherwise known as the “fear gauge”.
Going on “Tilt”
Similar to the game of poker, investing and trading are emotional endeavors grounded by analytics, research, and education. However, it’s arguably the appeal of risk-taking and the potential reward it brings that makes this business so attractive to newcomers. Obviously, that’s where ephemeral concepts like intuition and even the gambler’s fallacy come into play too – that is, the belief that a series of losses eventually guarantees a win.
Psychology Today, citing the Journal of Cognitive Neuroscience, claims that “many, if not all” decisions made on Wall Street are influenced by the trader’s mood and emotional state. Again, it’s easy to draw a parallel here with poker, with “tilt”, a term that describes a mindset that’s not conducive to strategic play (anger, frustration, sadness, etc.), tending to make players either more or less risk-averse than they normally would be.
Taking risks is one of our favorite things to do though. An infographic made by gaming site 888poker notes that the biological response to taking a risk and getting lucky is a complex thing, involving parts of the brain like the amygdala (adrenaline control), hypothalamus (fear processing), and the nucleus accumbens, which determines how reckless or careful we are in any given situation and dumps dopamine into our blood stream if we’re still alive afterwards.
The presence of dopamine in our brains means that humans are predisposed to take risks, and it’s debatable whether pastimes like extreme sports, blackjack and poker – or even trading stocks would exist at all without it; after all, without the biological reward for jumping out of a plane, what’s the point? There is perhaps an evolutionary reason for risk-taking though, allowing us to take chances on new technologies (like iron-working) or dangerous but fertile environments like the slopes of volcanoes.
Regret and Pride
For adrenaline junkies, the beauty of trading is that the thrill of winning out on a risky trade never goes away. Again, the research mentioned in Psychology Today and conducted by scientists from the Massachusetts Institute of Technology recorded heart palpitations even in hardened investors at times when the market was volatile, despite outwardly appearing calm. Traders also ignore their own intuition when things were going well.
There’s much to be said for the influence of two opposite but related emotions – regret and pride – on markets too, the former when an offloaded stock goes on to earn a premium and the latter when an owned one does the same. With all the above in mind, investing and trading stocks and shares is as much about thrill-seeking as it is earning money.
So, there you have it; trading – it’s just a casino game in disguise.