How Dopamine Affects Your Trading Results

June 4, 2024

Did you know that a hormone in the human body dictates almost every decision we make in our lives, especially our investing and trading decisions? It’s called dopamine. 

Dopamine influences financial decisions by enhancing the perceived value of potential rewards, motivating individuals to take risks for higher gains. It also reinforces past successful financial behaviors, encouraging similar future actions.

What is dopamine? 

Dopamine is a neurotransmitter that communicates between nerve cells in the brain and is linked to mood, motivation, sleep, and many other functions in the body. It regulates reward and pleasure centers in the brain, influencing our motivation to pursue activities in our lives.

When it comes to investing decisions, dopamine plays a bigger role in the motivation for the reward than in the actual reward itself.

For example, consider the feeling you get just before trading or investing in a stock, or the feeling just before opening your app to see the movement in the stock price. In everyday life, it’s the feeling you get before that first sip of coffee or before indulging in a delicious dessert. Our brain reinforces the feelings of anticipation and certainty about these activities.

Dopamine is released right before these acts, so it is the anticipation and the knowledge that these acts are going to take place that triggers the release.

So, how is dopamine relevant to my financial decisions? 

In today’s age of easy access via technology, you are just one click away from trading a stock or switching between funds within seconds. This instant gratification releases what is called ‘cheap dopamine,’ the type of dopamine that is easily achieved but needs immediate replenishment.

Activities like consuming junk food, endlessly scrolling on social media or binge-watching shows release cheap dopamine, leaving you always craving more and never completely satisfied.

These activities raise the baseline level of dopamine that your brain craves, meaning you need more of the activity to satisfy your cravings, leading to a cycle of addiction.

This is similar to logging into your app and trading in and out of stocks or frequently churning your mutual fund portfolio, driven by the constant overflow of information and the need to chase high returns quickly.

Such behavior hinders our ability to delay gratification and stick to a disciplined financial plan.

That’s some good information, but how does it impact my trading results?

The inability to understand how dopamine works in tandem with our decision-making can impact equity market trader’s decision-making abilities. 

A study done in 2012 by the neurology and economics team of Claremont University in the USA on Professional Wall Street traders showed dopamine’s role in accurately assessing risk and reward in trading.

The study involved 60 traders from five Wall Street firms and 54 graduate students from Claremont Graduate University in Southern California. The trader population consisted of 54 males and six females.

Traders who had a history of taking on excessive risk and traders who were too conservative in taking risks were the traders who had the worst results. 

Those traders who were somewhere in the middle, the ones who were able to balance the risk efficiently were the ones who did the best. These traders were not chasing returns too aggressively or being too conservative to avoid some risk in their portfolios. 

They were able to stick to their disciplined process to ensure uniformity in their trading.

The study concluded that, “Our sample of traders are analytical, integrative, and can delay gratification. They have a genetic profile associated with balanced levels of dopamine, and also linked to moderate but not high risk-taking behavior.”

Okay, how can I apply this dopamine knowledge to my trading and investing habits?

To ensure the balance of dopamine in our brains and maintain what is called ‘homeostasis’ or ‘equilibrium’ for easier understanding, we need to be consistent with activities that ensure the steady release of dopamine:

  • Avoid spending too much time scrolling through applications
  • Delaying gratification by focusing on a process rather than chasing returns
  • Not acting upon impulse decisions with easy access to information  

Human beings are desirous of some level of novelty and as soon as the novelty factor wears off, boredom starts creeping in which leads us to chase the next interesting idea. This can go on in an endless cycle if we do not have disciplined processes in place. Finding the next big multi-bagger stock every other day is due to this chase of novelty or trying to pick a fund that will multiply your money purely based on the past returns of the fund.

The ups and downs in the market cycle can impair our decision-making in the hunt for dopamine so it is important to understand what role this hormone is playing in our bodies to maintain a consistent process in our actions. 

Associate Vice President, PhillipCapital India

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