What makes a good investor? In a piece for CNBC.com, Elizabeth MacBride takes a look at some of the research that shows the answer can be found deep within investors’ brains.
In a recent California Institute of Technology study, for example, researchers found that investors in experimental markets had two distinct types of brain activity. “One was something along the lines of anxiety. Successful traders, defined as those who sold before the bubble popped in a lab, sensed in themselves an unease stemming from the perception of uncertainty,” explains MacBride. “They had higher-than-normal activity in an area of the brain known as the insula, which keeps track of how the body is feeling, said Colin Camerer, behavioral finance and economics professor at the California Institute of Technology. It’s known to be activated by financial risk.”
Other less successful participants seemed to chase returns and had a reduction in insula activity, “as if their brains think the price is following a very regular low-risk growth path,” said Camerer.
The researchers, who looked at how about 20 traders dealt with a risky asset over 50 trading periods, also found that just because investors had that uneasy feeling didn’t mean they would succeed. “In fact, there was another group that felt the unease but didn’t act on it,” writes MacBride. “They are people who would tend to say, ‘I felt something wrong in my gut but didn’t act on it.'”
MacBride talks about other research that shows investors also need to have a good “theory of mind” to succeed — that is, the ability to “understand that people around them are different and to guess what their actions might be.” And she offers some tips for how individual investors can be aware of their own investing predilections, and, if necessary, overcome them.