How to persuade your brain to moderate risk :: Business Line

I read an article explaining a recent research in neuroscience on risk-taking. The research, according to the article, shows that risk-taking is a physiological, and not a cognitive activity. Such research in neuroscience can help you moderate your risk attitude. How?

RISK AND TRADERS

The study argues that testosterone levels and risk-taking are related. The researchers found that when the testosterone levels of traders were higher in the morning, profits that they generated for the rest of the day were higher than when the levels were lower.

But higher profits mean larger bets, which when they turn bad can result in large losses. So, one takeaway from this study is that you can moderate your risk attitude by reducing your trading capital when your testosterone levels increase.

Of course, this is useful to professional traders and not necessarily to those who self-manage their investments. In any case, you know that success makes you overconfident, which prompts you to take more risk. In behavioural finance, this attitude is called Overconfidence Bias. This research essentially gives you one of the several biological reasons that lead to Overconfidence Bias.

POSITIVE FEEDBACK LOOP

In another study, neuroscientists found that risk-seeking individuals have increased activity in their nucleus accumbens (NaCC), which is the brain’s reward pathway. At the same time, the individual’s brain is flooded with dopamine, a naturally-producing chemical that activates the brain’s pleasure centre.

The NaCC and the dopamine can cause a positive-feedback loop. That is, the surge in the dopamine can get you excited, prompting you to take more risk. And this can lead to increased activity in the NaCC if your bets are successful, causing a further surge in your dopamine level. The risk-seeking individuals, in contrast, have more activity in their insula- the part of the brain that is related to pain and anxiety.

Understanding the factors that drive your risk attitude can help scientists eventually offer products to moderate your risk behaviour. Till then, you can adopt a simple rule to moderate your risk attitude: Suppose you invest Rs 5 lakh for five years and expect to earn 12 per cent a year. If the investment gives you a gain of 25 per cent in one year, take profits above 12 per cent. Why?

You may have invested Rs 5 lakh to accumulate Rs 8.8 lakh at the end of 5 years. Only if you invest the initial capital along with the expected annual return can you achieve your investment goals. You should, therefore, take out only the additional profits and invest that amount in bonds. This way, you can moderate your physiological urge to take more risk.

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