Our body can be a warning sign because risk-taking actually changes our body chemistry, according to John Coates, a former Wall Street trader turned neuroscientist who wrote the best-selling book, The Hour Between Dog and Wolf.
During a crisis, people are wired so that, as uncertainty goes up, our stress response goes up, along with our heart rates and breathing.
Coates, who works in the U.K. with hedge funds and asset managers, has seen these changes in himself.
Or at least his wife has.
On the night of the U.K. Brexit vote in December, for example, he was making money by selling sterling and buying gold and dollars.
“My wife was standing at the end of the kitchen table screaming at me,” Coates said. “ ‘Do more, do more,’ she said.”
“She could tell that I was in the zone, from the way I was carrying myself, from my body language. She could tell from that whether I shouldn’t be trading or I should be. I think a good trading manager should be able to tell when the risk takers are freezing up the risk aversion.”
Another time he lost a significant amount of money on trading Japanese yen, and his wife said she knew he was going to lose money on that trade.
“I said, ‘Why, what do you know about Japanese monetary policy?’ and she responded, ‘Nothing. But I know you. And you just didn’t look the way you do when you get the market right.’”
How can we recognize those changes in ourselves?
“Knowing the physiology goes a long way to helping you control it,” Coates said. “It’s extremely mysterious how it happens.”
On the emotional side, fear and greed can lead investors astray.
In fear, investors sell when the market is down, and in greed they buy when the market is high.
David Caldwell, a wealth adviser at ScotiaMcLeod, said historical references can help insulate investors from making chaotic moves.
Stock markets go up about 75 per cent of the time, Caldwell said, and he jokes with clients that perhaps they would be happier if he sent out their statements every five years.
Peter McGann, a financial adviser for Raymond James Canada, said market euphoria is a danger point.
It’s the point of maximum risk, when investors make their biggest mistakes.
On the other hand, investors who get complacent also sow the seeds of their own downfall.
You might recall there wasn’t a down month in the whole of 2017, but when the market slumped late in 2018, clients were clamoring to jump into cash.
Yet people who were on the sidelines in January missed one of the best months McGann has seen in some time.
Another mistake is having a short-term view.
Recessions typically last 11 months, and the average recovery lasts 58 months, McGann said.
Investors who know this are less inclined to pull money out.
It’s also important to have realistic expectations of how your portfolio is performing and tolerate the negative years.
When he meets with clients who talk of taking their money elsewhere, their rationale often is: “Well, we’re paying you a fee to lose me money,” McGann said.
The news landscape can also lead to bad decisions if you read only the headlines every day.
“The media will hit on whatever they think is kind of the sexy thing to talk about,” McGann said.
“They can really reinforce fear and reinforce greed in their reporting.”
If it were that easy, said McGann, financial advisers would not exist.
But one key misstep most investors make is over-estimating how much risk they think they can take: How much of a downturn can you handle before you panic, and why are you panicking?
“That’s where coaching comes in,” McGann said.
“I don’t think people understand their own risk tolerance.”