The following are excerpts from the NY Times article “Craving the High That Risky Trading Can Bring”
Neurofinance: an emerging field that combines psychology, neuroscience and economics, to examine how the brain makes decisions.
A small group of scientists, including some psychologists, say they are starting to discover what many Wall Street professionals have long suspected — that people are hard-wired for money. The human brain, these researchers say, responds to high-stakes trading just as it does to the lure of sex. And the riskier the trades get, the more the brain craves them.
Brian Knutson, a professor of psychology and neuroscience at the Stanford University, has sent volunteers through high-power imaging machines to map their brains as they trade. He concludes that sometimes, people get high on making money.
Neuroeconomics has not won many converts on Wall Street, however, the field seems to be gaining some traction. The editor of the Intelligent Investor, Jason Zweig, discovered that brain images of drug addicts who are about to take another hit are indistinguishable from those of traders who are making money and about to place another trade.
Daniel Kahneman, a Nobel Prize-winning psychologist, showed that individuals do not always act rationally when faced with uncertainty in decision making. When faced with losses, individuals may seek to take more risk rather than less, contrary to what traditional economic thought might suggest.
“When you are threatened with extinction, you act like nothing matters,” said Andrew Lo, a professor at M.I.T. who has studied the role of emotions in trading.
Mr. Lo and Dmitry V. Repin of Boston University have studied traders to determine how stress and emotions affect investment returns. They monitored traders’ vital signs like heart rate, body temperature and respiration as their subjects darted in and out of trades.
The findings, while preliminary, suggest — perhaps unsurprisingly — that traders who let their emotions get the best of them tend to fare poorly in the markets. But traders who rely on logic alone don’t do that well either. The most successful ones use their emotions to their advantage without letting the feelings overwhelm them.
People like to think that logic prevails in the financial markets, that traders and investors always act rationally. But Wall Street can get carried away. The Internet boom and bust were followed by an even bigger boom and bust in mortgage lending. Wall Street is now saddled with more than $100 billion in losses stemming from mortgage investments, and the economy may be sliding into recession.
