Are market prices an indicator of fundamentals or just feelings?
Posted July 25, 2012on:
I received this question from a subscriber to my monthly newsletter. To answer it, I must take a detour to our human brain structure.
We actually have three brains in our head!
In the center is the reptilian brain that we share with fishes, birds, and reptiles. It deals mostly with “housekeeping” and instinct, such as body temperature and hunger. The fight-flight-freeze fear response is handled here as well.
In the middle is the mammalian brain that we share with dogs, cats, and horses. It deals with feelings and memories, such as fear.
What distinguishes humans from animals is the “cortex,” especially the “prefrontal cortex” that handles language, logic, numbers, etc. It’s the thinking brain.
The more primitive is the brain, the more robust and automatic. It takes a lot of effort to read an annual report (using your thinking brain), but it takes much less effort to be fearful (using your mammalian brain) when prices are tumbling. Many people sell their stocks when they are afraid; that’s their reptilian brains at work.
For as long as we humans have three brains in our head, market prices will be an indicator of fundamentals, feelings, and instinctive reactions. To be a better investor, it’s crucial to be aware which brain is at work.
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