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Dopamine is the brain’s fun chemical.   

Originally scientists thought it was only released during times of high enjoyment such as eating chocolate, listening to your favourite music or, er, certain physical activities.  However, more recent research found that it’s a bit more subtle than that.  Dopamine motivates people to do things that they think they will be rewarded for doing – like checking your computer or smartphone. 

As Dr. David Greenfield, an Assistant Clinical Professor of Psychiatry at the University of Connecticut School of Medicine put it “Every time you get a notification from your phone, there's a little elevation in dopamine that says you might have something that's compelling, whether that's a text message from someone you like, an email, or anything."* 

This drive to incessantly check is particularly prevalent in the real-time price world of investing.  The ubiquity of data means that it is very easy to constantly check prices and levels. 

Loss Adjusters 

But there’s a problem.   

Not the addiction – no need to burn the iPhone yet, nor try to suppress any dopamine rush you may desire – but the issue is that when it comes to investing, short term price movements are likely to cause anxiety, not euphoria. 

Almost all investments have a degree of volatility, as the small print in the adverts tells us, investments can down as well as up but they usually do both in any given trading day.  Most of these price movements are fairly random and transitory.  However, during this process the investor is bound to experience some loss, either over the day, hour, minute, second, whatever.   

The human brain (yes, that again) has an inbuilt loss aversion which means that it feels loss a lot more than gain – on average feeling pain roughly 2 to 3 times more than gain.  Daniel Kahneman, a psychologist who specialises in behavioural economics, explains the origin of this trait, “When directly compared or weighted against each other, losses look larger than gains.  This asymmetry between the power of positive and negative expectations or experiences has an evolutionary history.  Organisms that treat threats as more urgent than opportunities have a better chance to survive and reproduce.** 

Filling Time

OK, so an investor’s brain may be wired to be particularly sensitive to losses but in general markets go up so there’s no worry – right? 

Well, markets do go down.  Considering the 2-times loss aversion, is it any wonder that investors felt they had lost everything when the UK stock market fell over 45% in the Credit Crisis?   

Looking shorter term, this can still be an issue, however.  Nassim Taleb, former trader and author of several excellent books on risk, gave the following illustration in his seminal work, Fooled by Randomness. 

He uses the example of the happily retired dentist who builds himself a nice trading desk in his attic, aiming to spend every business day watching the market while sipping decaffeinated coffee.  He watches his stocks via a spreadsheet with live price updates. 

The dentist finds a great investment that over time produces a 15% return with a volatility (dispersion of returns) of 10% per annum.  The volatility results in a 93% probability of success in any given year.  However, as the table below shows, over shorter periods, the probability of success narrows sharply:- 

 

Watching the screen minute by minute, the dentist has, on average, a 49.83% chance of being at least twice as disappointed as happy the rest of the time.  Like pulling teeth. 

As Taleb puts it,Over the very narrow time increment, the observation will reveal close to nothing. Yet the dentist's heart will not tell him that. Being emotional, he feels a pang with every loss, as it shows in red on his screen.”~

  

**Thinking Fast and Slow, Daniel Kahneman, 2012 

~Fooled by Randomness: The Role of Chance in Life and in the Markets, Nassim Nicholas Taleb, 2005