is a great brawl in which minds with opposing views battle over
whether prices will go up or down. Unfortunately, investors are
often their biggest foe in this arena because our brains have
biological mechanisms to screw us up.
Here are five reasons the self-sabotaging brain does this.
1. The drive to defend: Our brains love being right and hate
In their book, "Driven: How Human Nature Shapes Our Choice,"
Harvard Business School professors Paul Lawrence and Nitin Nohria
assert that humans are guided by four drives: acquiring, bonding,
learning and defending. We have an innate instinct to defend
ourselves, family, possessions and beliefs. As a result many
investors tend to stick with a losing trade, because they can't
admit that they're wrong.
In the modern age, being told we're wrong is as
physiologically threatening to our bodies as a lion was to the
Neanderthal. "Being wrong or thinking you are wrong causes
stress, which triggers stress hormones such a cortisol or
epinephrine," explains Dr. Janice Dorn, a psychiatrist and
co-author with Dave Harder of the forthcoming book "Mind, Money
"These neurotransmitters, if not shut off fairly quickly,
cause damage to the body through a variety of processes,
including, but not limited to, elevated heart rate, increased
respiration, mobilization of the body for fight or flight, and
inflammation," she said in an email.
Conversely, proving that we're right triggers an addictive
neurochemical process, Judith Glaser, CEO of Benchmark
Communications, wrote in a blog for the
Harvard Business Review
"When you argue and win, your brain floods with different
hormones: adrenaline and dopamine, which makes you feel good,
dominant, even invincible," Glaser wrote. "We get addicted to
Harvard economist John Kenneth Galbraith was known for saying:
"Faced with the choice between changing one's mind and proving
there no need to do so, most people get busy on the proof."
To combat the addiction to being right, Glaser recommends
planning your actions or outlining rules of engagement
beforehand. This means investors should plan ahead of time when
and why they would buy or sell their position.
2. The backfire effect: It's difficult to admit we're wrong
even when the facts prove we are.
We humans have a limited capacity to process information, and
even facts don't have the power to change people's beliefs.
Political scientists Brendan Nyhan and Jason Reifler observed in
an experiment that self-identified conservatives remained adamant
that Iraq had weapons of mass destruction even after receiving
evidence to the contrary. Likewise, liberal-leaning subjects
ignored facts that the Bush administration's restrictions on
stem-cell research were limited rather than banned
When our beliefs are proven false, we can fall prey to a
phenomenon that Nyhan calls
-- "a natural defense mechanism to avoid cognitive
dissonance." His research has found that people grip onto their
beliefs even tighter when shown the facts because it feels so
threatening to be wrong.
3. Confirmation bias: We tend to see only what we're looking
Most of us want to believe that we're open-minded and form
opinions based on evidence and rationalization. But we have a
natural tendency to favor information that agrees with our
beliefs, regardless of the facts. "Confirmation bias" makes us
selectively shun information that disagrees with our preconceived
Hence, conservatives prefer Fox News over MSNBC and vice versa
for liberals/progressives. Both sides of the global-warming
debate can look at the same temperature readings and draw
polar-opposite conclusions. Studies on wine drinkers show the
more expensive they think a wine is, the better it tastes. This
phenomenon applies to everything, Dan Ariely, a behavioral
economist at the Massachusetts Institute of Technology, says in
his book "Predictably Irrational."
"Confirmation bias is the tendency to search for and
overweight anything that favors one's own position," Dorn wrote.
"This bias causes traders or investors to become overconfident in
their positions and stay in these positions long after they
should have exited."
"They will continue to seek confirmation that they are correct
and often sell only when the pain of loss becomes too much to
bear," she added. "Even then, in the face of being clearly wrong,
the investor will find something or someone else to blame."
4. Wishful thinking: We believe what we hope to be true.
We often hold beliefs just because they're what we desire to
be true, despite reality or evidence to the contrary. There's no
doubt we have the power to make some desires come true, but the
markets are more powerful than all of our desires and wishes.
"It is more important to follow what the money is actually
doing than what we think it should do," Dave Harder, co-author of
"Mind, Money & Markets," who has more than 30 years of
experience as a portfolio manager, wrote in an e-mail.
All things being equal, we are more likely to predict positive
outcomes than negative ones. Fans tend to think their team is
better and more likely to win. Many buy lottery tickets even
though the chances of winning are often 1 in several hundred
"We cannot impose our needs or wishes on the markets, and it
is foolish to do so," Dorn wrote. "The markets don't know who we
are and don't care what we think or believe. Legendary trader
Jesse Livermore wrote as one of his trading rules in 1940:
'Wishful thinking must be banished.' "
5. Illusory correlation: We are pattern-seeking primates.
We have an inherent need to make sense or find an explanation
for everything we experience, even though events may be random --
a phenomenon called "illusory correlation." Once we've decided a
connection exists between different things, we look for
information that confirms our belief.
Fishermen who catch many fish in one part of the lake are
quick to conclude that's the sweet spot, even though it could
have been a fluke. A Midwesterner who gets rude treatment in New
York City might generalize that everyone in the Big Apple is
Gold investors assume that rising government deficits, dollar
debasement and central bank stimulus increase gold prices even
though gold plunged 28% last year as the Federal Reserve boosted
quantitative easing and the U.S. debt hit a historic record.
"It can't be proven that this was a cause-and-effect
phenomenon," Dorn wrote. "If it were this easy, there would be no
markets since everyone would be thinking and doing the same
Even if there was a correlation between gold prices and
quantitative easing in the past, there's no certainty that there
will be in the future. What's more, the economy has an infinite
number of moving parts at play and the environment constantly
evolves. Unlike science, economics can never isolate a given set
of variables in a vacuum to prove that one thing leads to
"In a complex adaptive system such as the stock market, it is
easy to identify correlations when they do not exist or exist
only on occasion," Dorn wrote. "One of the most common errors
make is to confuse luck with skill."
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