You can see stock prices in real time today. Buying and selling takes no more than a few clicks of a mouse or taps on your smartphone. In 1865, it took much longer.
Back then, it took mail ships eight days to cross the Atlantic from New York to London. On April 9, 1865, American investor Jim Fisk learned that the U.S. Civil War (between the northern-state Yankees and southern-state Confederates) had ended. Thinking quickly, Fisk chartered several ships he knew to be faster than the ones delivering trans-Atlantic mail. His ships arrived in London a day before the mail boats that were bringing news of the end of the war.
That one-day cushion allowed Fisk’s men to place orders with London brokers selling short Confederate bonds. (Selling short allows an investor to profit from a decline in price). As Fisk knew the Confederates had already lost the war, betting against their bonds was a sure thing. When news of the Confederates’ surrender arrived a day later, the price of the bonds plummeted. Fisk made a fortune.
Having too little investment information, and receiving it late, is bad. That’s a lesson that holders of Confederate bonds in 1865 England learned the hard way.
Fast-forward 150 years. Investment news now travels around the world in seconds. Anyone with a smartphone has immediate access to years of historical data, news, analysis and commentary on almost any stock or bond. That also means investors still have an information problem – but it’s the opposite of 1865, they now have too much information. And, it changes as fast as they can blink.
It’s hard being an investor in this fast-paced environment without making decisions based on your emotions.
We’ve written before about the role of emotions in investing. Investors with rules in place to reduce the effect of their emotions on the investment process are likely to come out ahead. In theory,psychopaths – people incapable of feeling emotion – should be great investors.
How does too much information cause your emotions to get in the way?
Humans are programmed to process information a certain way. So, any bit of news we receive about something we own – every gain or loss, story or expert opinion – brings with it a small pang of pain, or pleasure. As we’ve said, the pain of losing is a stronger feeling than the pleasure of winning. Watching a stock’s price tick up and down during the day takes you on an emotional rollercoaster.
Our reactions to profits and losses are actually involuntary biochemical changes in our bodies. To our ancient ancestors on the plains of Africa, important information was a matter of life or death. Knowing what was lurking behind a big stone or up a tree helped them avoid becoming a larger animal’s dinner. The adrenaline rush that kept them out of danger was an involuntary response.
Unfortunately for investors in the modern world, our brains have the same response to losing money – it can feel like a life-threatening event. Adrenaline is processed in the same part of the brain that processes investment losses. But this fight-or-flight behaviour has different consequences for online investors than paleo hunters.
Studies have found that the brain activity of an investor whose portfolio is making money is similar to that of getting high on alcohol, cocaine or heroin. A chemical called dopamine floods the brains of both investors who are doing well and drug users, causing a similar pleasurable feeling. Dopamine evolved as a sort of reward for “good” behaviour.
Studies have also found that novel and exciting new information produces more dopamine than something we already know. That means one hot stock tip creates a craving for another one. Winning is addictive.
Thus, just like ancient hunters, an investor who is plugged in to minute-by-minute alerts, breaking news and portfolio twists and turns gets a dose of brain chemicals every time a “life-threatening” or “beneficial” event occurs. All of the investor’s biochemistry has evolved to promote the very actions and behaviours that are bad for investing. So, those doses lead to poor investment choices.
How can someone defeat his own biochemistry to become a better investor?
First, invest using a carefully thought-out plan. Before you buy anything, write down the answers to the following questions: Why am I buying? When will I sell? What is my stop loss? What are my criteria for buying new investments? You should have safeguards in place to avoid impulsive, adrenaline- or dopamine-driven decisions.
Second, turn off the noise. There is nothing in the daily deluge of data that has any impact on your long-term results. Don’t fall into the trap of market-watching. Consider establishing a personal rule that you will only check on your portfolio once a day, or better yet, once a week or once a month.
Why? It’s probably no coincidence that Warren Buffett, considered by many the greatest investor of all time, has no stock quote monitors in his office. Buffett only does things that contribute to his investors’ long-term profitability, and always reacting to every bit of news isn’t one of them.