Super investor Warren Buffett suggests to investors who wish to follow his path, "Be afraid when others are greedy, and be greedy when others are afraid." This is the only way, apparently, to beat the markets.
A new brain study has attempted to show the differences between the 'fearful brain' and the 'greedy brain' using MRI scans. CalTech professors Colin Kramer and Alec Smith and their co-authors built an experimental stock market where subjects could trade and make real money. The researchers were able to control the 'real' value of the companies, meaning what the shares would be worth when trading stopped. The students traded for 50 'periods', meaning they were given 50 opportunities to buy or sell shares.
Over time, similar to reality, asset "bubbles" developed within the markets, the price of which rose rapidly in brisk trading, beyond their nominal value. When the "bubble" stocks rose, brain scans showed that areas of the brain associated with positive reward were activated strongly. In other words, their brains expected the money to continue to arrive, meaning they were greedy. However, in a small number of investors, the researchers noticed a different brain pattern - although the reward mechanism was also active in them, the fear mechanism was also activated at the same time, which apparently caused them to imagine the loss of income that the increases had already created for them.
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The brain difference also translated into actual investor behavior. Those who were driven solely by the reward system bought when stocks were on the rise and even at their peak. The fearful, as mentioned, experienced the reward mechanism, but did not respond to it every time it was triggered, probably because of fear. Even when they saw that the stocks were making them money (and their reward mechanism was triggered), it did not make them rush to repeat the same behavior and buy more. In fact, they were the ones who ultimately decided that they had enough, exited the market and actually caused the bubble to burst. The fearful were the ones who ultimately made more money.
""These subjects who made the most money had to do something very emotionally complex," Cramer said in a university press release. "They had to sell when the stock was up, and their reward system tells them they did the right thing when they bought. But their fear of losing the income they had already made helps them." The part of the brain that lights up only in those who knew when to get out and not in those who burst with the bubble is called the insula. It has previously been linked to emotions such as financial anxiety or risk aversion, and it is also activated when you experience physical pain, smell a bad smell or experience social embarrassment.
It should be noted, however, that the investors who made the most money were not those driven by fear alone. Those who were afraid of any involvement with the stock market - even the simulated one set up for the experiment - did not buy much and did not sell much, and as a result did not profit or lose, a situation that in the real world translates into the erosion of the value of money. The winners were those who were brave enough to enter the stock market with force, but not only in stocks that were in an upward momentum, and also dared to exit early, without fearing that they would miss the celebration.
The researchers discovered something else in the experiment - bullishness forms naturally in an experimental market, without anyone giving investors any information about the stock. The bubble in this experiment resulted from the existence of previous purchases that increased the stock's value for several consecutive days, and the formation of a pattern of repeating what works for investors who were motivated by greed. This, contrary to what some economists claim, is that bullishness is created only thanks to disinformation or media hype.
