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Funny Business
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When you pick up the phone to chat with your financial advisor at Goldman [GS
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], or Morgan Stanley [MS
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] or JP Morgan [JPM
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] or Merrill [BAC
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] or...wherever...does it drive you nuts that your advisor seems less upset than you are, even when his or her income depends on your portfolio's success?
Now we know why.
Researchers at Caltech and NYU have released a study which attempts to scientifically explain the difference in emotional responses to stock losses by professional traders and amateurs. Researchers asked subjects to make 140 choices "between a risky gamble and a guaranteed amount of return." The choices were broken down into two sets using two strategies. One strategy was to emphasize each choice in isolation. The other strategy was to look at the choice as one of many. The theory is that amateur traders tend to focus on choices in isolation, investing more emotional capital along with real capital, while professional traders tend to take a "big picture" look at choices, evaluating them as part of a larger portfolio of decisions. That larger perspective, scientists theorize, makes individual losses less emotionally devastating.
The results? Those who made choices in isolation literally sweated more. "That is, they were more concerned about avoiding financial losses than in making financial gains." However, when using a strategy looking at the big picture—that is, when thinking like a pro—"average levels of sweating per dollar were about the same for gains and losses."
I have no idea what "average levels of sweating per dollar" involves, but I'm imagining researchers measuring flop sweat dribbling off computer keyboards into buckets as test subjects make their choices.
The findings are in the latest issue of "Proceedings of the National Academy of Sciences", where researchers suggest that individual investors can learn to trade like a pro...emotionally, if not as successfully. They also suggest that changing to a "big picture" perspective may actually change the types of choices you make. You will be less "loss averse" and more willing to take chances. "Specifically, the findings support the conclusion that professionals have learned not just facts about investments, but also strategies for limiting the normal emotional response that might prevent amateurs from making the same decisions given the same information."
Is that a good thing? Should amateurs bolster their emotional armor only to make riskier trades? Well, at least you won't sweat it, literally. Co-author Colin Camerer of CalTech says, "Showing that emotional reactions can be turned on 'mute' shows both that those emotions are genuine and that they can be controlled, which gives a fresh perspective on the role emotional control may play in the economy."
Read More About Trading Psychology on CNBC.com including:
- 5 Reasons to Get Back Into the Market
- Three Simple Trading Lessons
- Managing the 5 Emotional Stages of Investing
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