Volatility is to Investors as a Flame to a Moth?

You Have To Be Brain Damaged To Be A Careful Investor In This Market

Myles Meserve | Jul. 23, 2012

http://www.businessinsider.com/a-new-study-explains-why-investors-find-it-so-hard-to-sit-on-the-sidelines-2012-7 

The Wall Street Journal reported that a new study published in the Journal of Neuroscience suggests to explain why investors find it so hard to buy and hold investments while watching volatile and profitable opportunities occur elsewhere in the markets.

According to the study, it all depends on a region of the brain, known as the frontopolar cortex, which contributes to predicting rewards.

The experiment used three groups of people, one group with damage to the frontopolar cortex, one group with damage to other parts of the brain and one other control group with healthy brains.

The experiment used four identical slot machines that had varying pay-outs.

The scientists found that the two groups of people who had healthy frontopolar cortex, tended to make their next bet based on the scale of the machine's previous two pay-outs. And, when the pattern of the pay-outs from one machine changed, the two healthy groups would move to the next machine.

Those who had a damaged frontopolar cortex, the part of the brain where reasoning occurs, didn't try to outsmart the machines, and tended to make decisions based on the cumulative history of each machine's pay-outs, not the short term trends. Also, those with a damaged frontopolar cortex, were more likely to admit defeat and quit searching for patterns in random data sets.

This study shows that humans with a damaged frontopolar cortex are more likely to hold an investment for the long term, while those with healthy brains, are constantly tempted by what they believe are patterns that are profitable and recurring.

So when healthy brained people see volatility they try to find the pattern to trade. The problem is, there may be no pattern at all.