Neuroeconomics – vital for avoiding investment pitfalls


Roger Eskinazi | Managing Partner | Tickmill South Africa | mail me |

Traders and investors must overcome many hurdles in order to succeed. Among the most common of these hurdles are emotional pitfalls such as fear and greed, and behavioural shortcomings such as impulsivity.

Neuroeconomics – a relatively new discipline – may hold the key to understanding the neural processes that govern the way traders make decisions, and assist them in making the right ones.

Success as a trader hinges off the ability to make decisions, often in complex and volatile market conditions. So while traditional trading strategies may centre around conducting financial analyses and looking at technical indicators, understanding the role played by the brain in making decisions can add another level of invaluable insight to the process.

Neuroeconomics is an emerging field of study that exists at the intersection of neuroscience, psychology and economics. Proponents of this academic discipline, explore the cognitive, biological and emotional factors that influence individual choices, with a particular focus on decisions that are financial in nature.

One aspect that might be considered is how the brain evaluates and weighs up information on the financial principles of risk and reward – being able to build robust investment portfolios that strike this balance, is a critical skill. Ultimately, by understanding the inner workings of decision-making, traders can optimise their strategies, mitigate risk and navigate market complexities.

The business of the brain

One of the key premises of neuroeconomics is that traders and investor make decisions based not only on rationality and logic, but also on emotions, cognitive biases and social influences. These factors however, are not only products of neurological processes but also results of patterns of behaviour.

Dr Andrew Menaker, a licensed clinical psychologist and performance coach, and a recent guest on our Bright Minds podcast, discussed this point, asserting that emotions are both ‘body states’ and ‘brain states’ occurring simultaneously.

For example, under conditions that are uncertain or unpredictable, traders may experience feelings of anxiety. They may also experience high levels of ambiguity in the way they make decisions, based on their personal history and experiences. Likewise, much rests on physical factors such as the quality of sleep they are experiencing, which in turn impacts the way they perceive and tolerate risk. There is therefore much beyond the data, graphs and technical knowledge that goes into how traders make decisions.

How to make neuroeconomics work for you

Armed with this level of understanding around the factors that influence decisions, traders can leverage neuroeconomic theory to optimise the performance of their investments. Weighing in on some of these practical tips, traders are recommended to spend time understanding the concept of cognitive biases in trading.

One example of this is ‘anchoring bias’ or the tendency for traders to rely heavily on the first piece of information they receive (the anchor), when making subsequent trading decisions, even if that information is irrelevant or misleading. To mitigate this, traders should strive to adopt a flexible and objective approach to decision-making that involves reviewing information against other sources, general market trends and opposing arguments in order to gain a balanced and informed view.

Another simple technique that traders can employ is to keep a trading journal. Many traders rely on journaling to track their progress, monitor the results of their trading decisions and identify common errors in judgment.

As an additional layer of record-keeping, traders should note down any emotions, knee-jerk reactions, thoughts and physical sensations that arise when making decisions. These emotional and social factors will provide traders with important reference points that can be immensely helpful for future trades.

In conclusion

The time-old advice that many sage traders offer newcomers to the industry is to stick to a trading plan as closely as possible, particularly within the first year or two of trading.

A trading plan will provide traders with a decision-making framework that is structured and will act as a reminder of longer-term goals and objectives. Keeping these goals in mind and sticking to the pathway will help cut through any ambiguity and counteract disruptive emotions such as fear and greed.

Gradually, as you mature in your proficiency and ability as a trader, you will learn when to deviate from your trading plan in a way that doesn’t hamper your view of the bigger picture.



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