Investors’ Brain

I was forwarded this article from Bloomberg recently.
It’s most relevant in the volatile market environment we are now in.
Be vigilant of your own emotions when making that buy, sell or do nothing investment decision. All the best, Wai-Yee

Brain Scans Light the Way to Do-It-Yourself Investing
By Ben Steverman Oct 8, 2014 5:10 AM ET

September was “hell on earth” for Walter Ribeiro. A 29-year-old resident of Dublin with Portuguese and Brazilian roots, Ribeiro is heavily invested in Brazilian stocks that were slammed last month. A 21-percent gain for his portfolio year-to-date turned into a 10 percent loss.

“You can find yourself thinking about stocks all day,” Ribeiro, a full-time project manager and part-time college student, says of his mood then. “I really started to doubt myself: Why did I do that? Am I really doing the right thing?” On weeks his stocks did really badly, he would cancel weekend plans.

This is why people hire financial advisers — they help shoulder the stress. At the same time, they can be expensive, they can have conflicts of interest and it’s hard to know which ones to trust. Fortunately, the services and tools available for do-it-yourself investors are better and more useful than they’ve ever been.

Just as important: New research is helping investors understand what drives their financial decisions, so they can prevent emotions from costing them money.

The new field of neuroeconomics is giving investors insight into the brain chemistry behind their market moves. When volunteers for a lab experiment contemplate risky investments, brain scans show it lights up their anterior insula, the deep part of the brain that processes fear and anxiety. Other studies show the more anxious a subject becomes in a lab — anxiety can be induced more conveniently with rotten food or scary images than with junk bonds — the less confident they are in identifying investment opportunities.

So even contemplating investments can make people basket cases — and then their moods undermine their decisions.

“It’s a double whammy,” says University of North Carolina finance professor Camelia Kuhnen. A stressful day at the office, or a fight with a spouse, can make an investor overly cautious. And research on the brain chemical dopamine and the so-called “reward center” of the brain shows that the opposite is also true: A great meal or successful date can push investors to pile on the risk. Genes may even play a role, says Kuhnen. Some people have a gene that predisposes them to be more anxious investors, while others have a gene associated with risk-taking.

More on Do-It-Yourself Investing:

Three Ways to Get a Steady Paycheck Long After You’ve Retired
Slay the Little Beasties of ETF Investing
You’re Not a Piñata. Find a Financial Adviser Who Knows It
An Investor’s Guide to Fees and Expenses 2014
Without some radical and very stupid surgery, there’s no way to turn off the anterior insula or the dopamine. But if investors don’t trust themselves to stay cool, they have more online tools today to help them keep emotions in check.

These tools prevent do-it-yourselfers from screwing up by limiting how many decisions they have to make. Target-date funds, for example, automatically buy fewer stocks and more bonds as retirement approaches. Online brokers can take clients through a questionnaire, suggest an appropriate portfolio of cheap index funds or exchange-traded funds and then re-balance those funds regularly – all without more than a few clicks of the mouse — for little more than you’d pay if you bought the funds on your own.

Those who want more active control of their money need to accept that they’re not as rational as they think, and work harder to master their emotions. A small but growing group of mental health professionals, financial planners and academics is trying to help through a field they call “financial therapy.”

Therapists can teach calming techniques, like breathing exercises or muscle relaxation. They can also plumb a patient’s past to help him understand why he behaves irrationally about money. A parent’s credit card problems may leave an adult child petrified of debt, for example. People find it easier to change their behavior when they understand what’s really motivating it, says Kristy Archuleta, a Kansas State University professor and editor-in-chief of the four-year-old Journal of Financial Therapy.

Ribeiro doesn’t have a therapist. But he does occasionally email about investing with a former teacher. Those conversations helped him hold on to his stocks rather than panic and sell at what might be a bottom. “I’m trying to stay calm,” he says. He reminds himself he’s saving for retirement, not trying to make a quick profit.

That’s smart. It’s also a difficult attitude to maintain when markets are crashing and savings are evaporating. The upside is that, as with anything, it gets easier the more you do it. And mental stamina — the discipline to stick with well-laid investing plans — is a big part of being a successful investor.

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http://www.bloomberg.com/news/2014-10-07/brain-scans-light-the-way-to-do-it-yourself-investing.html

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The simple way to get more control over your risk

Though this article was published in July 2014, recent volatility is evoking the potential of this strategy again. Using different strikes but principles remain. Long Straddle.

long straddle

Published 08 July 2014 10:04

Having enjoyed a solid last week that saw the Australian share price index rally from below 5440 to around 5520, the question for traders is can it maintain momentum. John Wasiliev

There is a popular perception that every trading strategy involving derivatives is risky. While it’s likely that if you go for the maximum reward, you’ll be taking the maximum risk, there are strategies to give traders some control over risk.

In a low-volatility market like the present, where a trader is convinced something major could happen but not certain about the move, whether it will be up or down, these possibilities can be risk-managed with an exchange-traded options strategy, known as a straddle, over the ASX 200 index.

Buying a straddle over the XJO index, says Wai-Yee Chen, a senior adviser and derivatives specialist with Ord Minnett, is having an each way bet where the position you take establishes a range beyond which you expect the shares to move.

The range in this instance is between 5400 and 5600.

With the ASX 200 XJO index about 5520 on Monday after having risen above 5500 last week, a straddle could involve buying a September expiry 5550 index put option at the same time as a 5600 index call option for a total straddle cost of 170 points with each point worth $10.

At Monday’s index level, the put cost 136 points and the call position 34 points. Chen says whichever direction the market heads, this can be covered by the straddle, especially given the low volatility.

If the market retreats to the 5400 region, the put position should rise in value to about 204 points and the call back retreat to just 7 points.

Should the index approach its year high of around 5560, the respective values of the put and call at 118 points and 50 points, a total of 168 points, will be just below the initial cost.

At 5600 the put will be worth around 102 points and the call around 72 points for a marginal profit of 3.5 points.

Chen says the strategy is biased towards the downside with a 20 per cent gain if the market retreats to 5400. There will be a slight loss or modest gain between 5560 and 5600.

Having enjoyed a solid last week that saw the Australian share price index rally from below 5440 to around 5520, the question for traders is can it maintain momentum, pierce through the key resistance level at 5500 and stay above this.

With the index still around 5520 on Monday, OANDA technical analyst Stuart McPhee suggested traders are likely to recall its previous efforts to break through 5500 and continue higher after having retreated to around 5400 from where it has moved back and forth in the last six weeks.

Any substantial break is likely to be regarded as a significant move. McPhee believes it is quite likely many traders are sitting on the sidelines waiting for the break before committing themselves.

This story originally appeared at afr.com.au.

3 keys to losing fear

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“The media is full of stories saying a crash is coming, or a correction is expected – it seems like the best time to buy is always tomorrow instead of today. How do you overcome this?”

The stock market feeds straight into our primal instincts of survival. It has been there with primates to survive in the wild and it has continued to be so for us now, though it’s not just simply physical safety and food, but now it’s in the form of money, the currency of survival.

Each of us expresses this survival instinct differently when it comes to money. Some just want to protect what they have and the fear of losing is pronounced. Though this instinct is inherent in all, but to some, it’s more pronounced and dominant. This dominant tendency may be in the group of people who have lost money in the past, due to failed businesses, scams or bad investments or just bad investment decisions, in addition to those who do not have the capacity to replace their savings. For this group, the fear of losing tends to be the dominant factor in their decision making when it comes to money.

Negative news and noises tend to be given higher scores when it comes to decision making. These “noise” or information tends to ignite the fear quicker than the average person. Warning signs may be taken as alarm bells and preventive actions may be taken prematurely. These can be in the form of selling shares too early to lock in small profits whilst missing out on the big rally. Acting irrationally and impulsively by over-reacting to negative news and stories in the media is one such act that those with this tendency needs to prevent from. Inactivity (when one should be acting) is another product of this tendency.

This sensitivity can have positive effects though if one learns to use it as a signal “to pay attention”. They can be more careful investors than the average and this tendency can translate to more circumspect strategies in managing risks of negative events, like gradual profit taking or the taking on of downside protective strategies or investing in less risky investments.

So, the fear of losing is normal, however if it is dominant in one, then there are strategies to balance it out when investing and dealing with money. Firstly, recognise that it is dominant in you. Then one can invest differently to reduce the incidences of this sensitivity be triggered resulting in impulsive decisions. These can be investments with downside protection, those that have less volatility and lesser risk for big movements. Thirdly, as a longer term strategy, consciously overlay money decisions with a filter of neutrality when it comes to information and the consideration of risks to the downside and losses, asking one questions like; “Am I being objective here, am I only focusing on the negatives, are there more upside to the fear of possible downside?” or even, “Am I overly negative and bias in this decision?” This helps and forces one to be more neutral and objective and hopefully reduces decisions that are biased by this dominant factor of fear of losing.

Wai-Yee Chen
5 Oct 2014