Could hormones be blamed for a stock market crash? What drives investors to make irrational decisions? Kabir Sehgal, author of the book Coined: The Rich Life of Money and How Its History Has Shaped Us, discusses several variables that lead to poor money management and, ultimately, to market risk. For example, research suggests a link between risky financial decisions and elevated testosterone levels. Beyond body chemistry and endorphins, certain logical biases and fallacious thinking could also endanger a portfolio. Take for example the availability bias, which describes situations in which recent the more likely you can recall something, the more likely you're going to invest in it. Sehgal explains that investors need to fight against subconscious urges to make irrational decisions.
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Transcript: It is true that on Wall Street and among traders there's a lot of endorphins being produced. In fact they've studied traders in the London Stock Market, London traders, and they found that sure enough that those who take on significant risk may have increased levels of testosterone. They found a correlation between those with high testosterone and high risk taking. And also causation, some studies showed that if they take nasal spray of testosterone you're more likely to take financial risks. So it's not just in Wall Street, it's also in a lot of financial decisions when you're in a casino. Those who have the certain chemicals are more likely to take certain financial decisions.
The most important thing about an investor is someone who can detach themselves from irrational activity. For example, one investor who I know went to Japan recently and looked at all kinds of banks and met companies and tried to figure out what should he invested in Japan. But when he came home to America he decided he was not going to invest in Japan for three to six months. And why is that? Because he felt that he may be subject to the availability bias. Meaning that the more likely you can recall something, the more familiar you are with something the more likely you're going to invest in it. That's why people play the lottery. My dad plays the lottery every single week and I ask him, "Dad why do you play the lottery?" He says, "Well, I see people winning the lottery on the news. I may win it." I said, "Well, you're not seeing the hundreds of thousands of people that are losing." So, professional investors can create checklist to start rooting out their bias, whether it's things that they can easily remember or things that they're familiar with and they can check themselves to make sure that they're not making irrational financial decisions.
Markets are very volatile when they're going down. It's because it encourages irrational activity. When you're losing money some traders try to double their bets to try to make up their losses so they don't realize losses, they want to keep on doubling down, doubling down. That's why you have these incredible trading losses because some traders are just loose cannons and they don't want to lose money, they want to make money so they keep on making irrational financial decisions. And that's why when the stock market gradually goes up and then it plummets when it goes down.
