Cocaine and investing are worlds apart - one is illegal and dangerous while the other holds some satisfying payoff despite the element of risk. However, a Harvard study said that both activities are interpreted similarly by the brain.
Using brain imaging, the researchers discovered that the areas of the brain that responds to reward and pleasure are both activated in a person high in cocaine and to that of a person whose investments suddenly gave him good returns.
In simpler terms, a gambler and a cocaine addict's brain responds similarly when they win or got a shot respectively.
The study sheds light to how investors can be subject to irrational biases when they do business just like an addict is to cocaine. Despite priding themselves as logical and rational individuals, there's a psychological dark side in investing that traders should look out for.
This dark side is the same as a cocaine addict's need to get stronger shots as the addiction gets worst. In the same way, if investors don't watch themselves, they could get addicted to the winning feeling and they would be tempted to make a bolder and bigger bet without weighing the pros and cons of the decision - there goes critical thinking off the window.
Author Jason Zweig wrote in his book "Your Money and Your Brain," financial losses and danger is processed in the same area of the brain. And the effects of these responses, when left unchecked, has lasting effects not only in the brain but also in the physical body.
The only way to prevent such psychological biases is to discipline your mind with constant reality checks about your decisions. Admitting to yourself that you are not as rational as you think you are and that you are prone to such biases will keep your feet firmly planted on the ground. Realizing that weakness makes you more careful and, eventually, will prevent you from making irrational decisions.
