Recent advances in neuroscience and physiology have shown that when we take risk, including financial risk, we do a lot more than just think about it.
We prepare for it physically. Our bodies, expecting action, switch on an emergency network of physiological circuitry, and the resulting surge in electrical and chemical activity feeds back on the brain, affecting the way it thinks. In this way, the body and the brain string together as a single entity, united in the face of challenge.
Normally, this fusion of body and brain provides us with the fast reactions and gut feelings we need for successful risk-taking. But under some circumstances, these chemical surges can overwhelm us. And when this happens to investors, they come to suffer an irrational exuberance (or pessimism) that can destabilize the financial markets and subsequently wreak havoc on investors’ wealth creation process.
Consider bull markets. When rising stock prices start to validate investors’ belief, the profits they make translate into a lot more than mere greed. They bring on powerful feelings of euphoria and supremacy.