NEW YORK (MONEY Magazine) - Wolfram Schultz, a neurophysiologist at the University of Cambridge in England, is so fastidious that he turns his office teacups upside-down on a towel when he's not using them, lest they get dusty. Schultz has the right temperament for someone who explores the microstructure of the brain, monitoring the electrochemical activity of one neuron at a time.
Schultz studies the workings of dopamine, the brain chemical that gives you a "natural high." Dopamine is what makes you feel good when a stock you buy goes up, and neurons transmit that chemical to many parts of the brain, including the nucleus accumbens. The latest scientific discoveries about dopamine have huge implications for investing.
| The Brain tour
|
|
|
|
|
First, your brain loves long shots. The less likely or predictable a reward is, the more active your dopamine neurons become and the longer they fire -- flooding your brain with a soft euphoria. "That positive reinforcement," says Schultz, "creates a special kind of attention dedicated to rewards. Rewards are what keep you coming back for more." That release of dopamine after an unexpected reward makes humans willing to take risks. Without it, explains Baylor's Read Montague, our early ancestors might have starved to death cowering in caves, and we modern investors would keep all our money under our mattresses.
The dopamine rush we get from long shots is why we play lotto, invest in IPOs, keep too much money in too few stocks and invest with active portfolio managers instead of index funds. It's why phrases like "the next Microsoft" or "the next Peter Lynch" make us whip out our wallets. Even if you've never experienced such a big score, you're wired to want them. Dopamine makes winning big feel vastly better than just winning -- and the prospect of its euphoric effect prevents us from focusing on how small the odds of winning big actually are.
The second dopamine discovery is reminiscent of Pavlov's dogs. Russian physiologist Ivan Pavlov would ring a bell whenever his laboratory dogs were to be fed. After a while, they would drool at the mere sound of the bell, before the food even arrived. Dopamine works in a similar way. Once a gain becomes associated with a particular cue, your brain releases dopamine on that cue -- before the gain occurs.
A team led by Harvard's Hans Breiter found a "striking" similarity between the brains of people trying to predict financial rewards and the brains of cocaine addicts and morphine users. In effect, as investors, we get stoned on our own belief that we know what's coming. As time passes, we may get more of a dopamine high from predicting a coming gain than from earning the gain itself. Thus back in the booming bull market of 1999, day-traders got a "buzz" just from sitting down in front of their computers if their previous trades had been profitable. (That dopamine buzz probably made their next trades even more aggressive.) And when Cisco had beaten Wall Street's earnings forecasts for 25 quarters in a row, just the approach of its next earnings announcement made investors feel euphoric. (Perhaps that's why Cisco's price/earnings ratio hit an electrifying 196 times earnings by early 2000.)
The third major dopamine finding: Once you've learned which cues seem to predict a coming gain, something strange happens if that reward fails to materialize. Your neurons still flood your brain with dopamine when you encounter the cue, giving you that "prediction high." But your dopamine dries up instantly if the gain fails to arrive when the cue suggested it would. It's as if someone yanked away the needle just as an addict was about to get his fix. This wrenching swing from euphoria to depression -- which can take place in less than two seconds -- may help explain why the market overreacts so harshly to any short-term disappointment.
|
