If you panic during a market fall, its not your fault. Blame it on..

10 minute read

Let me begin with a simple question:

When you sense danger what is your immediate response?

While you have your answer ready, let us verify from some real life examples..

The immediate response for most of us is to immediately flee from the perceived danger!

But some of us have a slightly different response..

Some decide to confront the threat and take the danger head on instead of fleeing!

So in essence whenever we perceive danger, we have two types of response.

  • Confront the threat and deal with it, or
  • Get as far away from the threat as quickly as possible

Psychologists call this the “Fight or Flight” response.

It was first described in 1915 by American physiologist Walter Cannon.

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Cannon’s insight was that both humans and animals, meet a sudden threat with the same biological response – a state of impulsive nervous excitement which mobilizes the body’s resources and prepares them to either run away or fight.

But hang on. There is one more response to threat that we are all familiar with.

Do you remember the first time you had to give your speech in front of a large audience?

What happened?

Most of us froze!

Most of the school shoot out out survivors also had the same initial response.

“At first, everyone just froze, trying to understand what was happening. It took a little bit for us to realize this was a shooting” – A Virginia Tech school shoot out survivor

In fact, even the legendary Arnold Schwarzenegger has used this “freeze” response when faced with danger!

Thus that adds a third response and our equation becomes :

Response to danger = FREEZE or FLIGHT or FIGHT

Now if you noticed, all the responses to the perceived danger happened lightning fast within a fraction of a second.

This leaves us with an interesting question:

How did people literally in the blink of an eye swing from a casual state to one of outright terror with adrenaline pumped into every muscle of the body?

Is there more to it than what meets the eye. Let us explore further.

A few million years back..

For answering these questions, I will have to take you back by a few million years to our stone age ancestors.

The stone age version of you unfortunately doesn’t have the comfort of Swiggy. So you have no other choice but to go out and hunt for food every day.

As you go out into the forest in search of food, suddenly you hear a mild ruffle of leaves amongst the trees a few hundred meters in front of you.

Your first reaction – You freeze.

You stop moving for the fear of attracting the attention of the unknown predator.

In a few seconds you can hear the sound of something coming towards you. In the next instant, you are running for your life and scrambling up the nearest tree.

As you watch from the top, you heave a sigh of relief. Its a harmless deer.

Welcome to the life of your ancestor – freeze, flight or fight were their day to day survival mechanism.

But hey, it was just a harmless dear. Don’t you think you overreacted. You should have just waited for a few more seconds and then decided.

Here is the problem.

If it had been a tiger instead, the few extra seconds you took to decide on whether to run or not would have meant – a nice lunch for the tiger.

The downside of mistaking a deer to be a tiger, is still minimal (just some energy wasted climbing up the tree) compared to the possibility of losing your life.

In a world filled with too many threats everyday, “React first – Ask questions later” was the modus operandi.

But there was one man who was unsatisfied with these explanations. He needed to know more, on exactly what was happening inside the brain during these moments.

Meet the American neuroscientist Mr Joseph E. LeDoux

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In his endeavor, he faced a fundamental problem. Human brain is extremely complicated. So to conduct experiments directly on the brain was extremely risky. So neuroscientists mostly had to wait for people with some new form of brain damage to study the functionality of different parts of the brain. But waiting each and every time for someone with a brain damage was too time consuming.

Impatient Joseph E. LeDoux came up with a proxy to humans – the lab rat!

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Now he had another problem – how will he create the emotion of fear inside the brain of the rat?

Thanks to Pavlov’s experiments, he constructed a similar one. Put a rat in a cage, play a tone, and simultaneously deliver a shock to the animal’s feet through the floor of the cage .

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After a few rounds of tone and shock, the rat started to fear the tone even if was not accompanied by the shock. The fear reaction was noticeable because the rat suddenly froze in fear.

Now the next logical step was to find out which area of the brain was involved each and every time the tone was played and fear invoked. For this he used a system, which anyone used to repairing their old desktop computers would be familiar with.

He surgically eliminated different parts of the rat’s brain one by one and tested the rat’s reaction (remember these were the days before advanced imaging technology). The logic was that if you remove a region and the rat can still learn to associate the tone with the shock, then the region you’ve removed isn’t relevant to fear response. But if the rat stops learning, you know you’ve got something relevant.

This is when he found something mind boggling.

The earlier understanding was that the sound enters via the rat’s auditory thalamus (think of it as a recorder) and is sent to the auditory cortex (read as the portion of the brain which converts whatever we listen into conscious awareness).

As expected when he removed the rat’s auditory thalamus, the rat could sense no fear as it became deaf and couldn’t hear the tone.

But here comes the shocker.

Next he removed the auditory cortex which meant that technically the rat shouldn’t be able to hear anything as the cortex was the one which actually transforms external sound information into the conscious experience of sound.

But shockingly the rats froze when he played the tone.

If the rats were not consciously aware of the tone, and yet were getting afraid, it meant there was an alternate unknown route. The sound was traveling from the auditory thalamus to a mysterious region in the subconscious mind which could still hear the sound.

What was that mystery region?

In true James bond style, he injected a particular chemical called tracer dye into the rat’s brain and traced out the regions where the audio signals were being sent from the auditory thalamus.

It turned out that the signals were indeed being sent to another region

That mystery region was called the AMYGDALA!

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Amygdala is an almond shaped region found at both the left and right hemispheres of the brain. Taken together, these two regions form the “fear headquarters” of the brain.

The amygdala works as a threat surveillance system and is constantly working each and every second of the day, irrespective of whether you are awake or asleep. It monitors all the sensory information around you constantly searching for potential threats.

The amygdala is alert, vigilant, paranoid and has an itchy trigger finger

The moment it detects a threat, it sends the alarm signal, setting off a flight, fight or freeze reaction within milliseconds. Its so quick that the fear reaction is fired up much ahead of when the conscious part of the brain registers the actual threat and tries to interpret it.

Thus we all react emotionally much before we actually have a clue on what is going on.

This is extremely important and let us spend some more time on why this happens..

Actually, each and every time, there is a threat, the experience of danger follows two pathways in the brain:

  1. Conscious and rational (referred to as high road)
  2. Unconscious and innate (low road)

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It might take a few seconds to establish the presence of the threat and formulate a response via the high road, but the low road kicks the body into a freezing response within a fraction of a second.

The low road immediately pushes the body into the flight, fight, freeze response. In fact, it knows the response so well that it is nearly impossible to keep it from happening.

So the key thing to note is that, whenever our amygdala detects a threat, more often than not it overrides the rational thinking brain given its raw speed and instant push to action.

Now as a survival mechanism, in a world filled with too many threats this made perfect sense. But in today’s world which is far more safer, the amygdala might get triggered for the wrong reasons leading us to take unwarranted actions.

Now if you are wondering what does this have to do with investing.

Hold your breath.

Financial losses are processed in the same amygdala!

The amygdala has mistaken the threat from a financial loss to be equivalent to a tiger running at you.

This means much before your conscious brain can really interpret the losses, your amygdala has already set the trigger on – and mostly we take the freeze or flight response.

In an app led investing world, where it just takes less than 30 seconds to sell all your holdings, amygdala is on steroids!

Now you know the answer as to why its extremely difficult to stay sane during a bear market. As your amygdala gets triggered due to successive falls day in and day out, you eventually give in.

So the key takeaway for us is simple:

While our intentions maybe not to panic during a market crash, our brains are designed in such a way that most of us will freeze or sell out during a crash.

The most important thing is not to overestimate the power of our rational brains during these times and to acknowledge that our amygdala will usually override our rational brain.

Now does that mean all is lost.

But wait. There are some people such as army men, bomb diffusers, firemen etc who are trained to make good decisions in extreme high pressure situations.

How do these guys resist the amygdala impulse?

Wait till the next week..

(to be continued)

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You can also check out all my other articles here
Disclaimer: All blog posts are my personal views and do not reflect the views of my organization. I do not provide any investment advisory service via this blog. No content on this blog should be construed to be investment advice. You should consult a qualified financial advisor prior to making any actual investment or trading decisions. All information is a point of view, and is for educational and informational use only. The author accepts no liability for any interpretation of articles or comments on this blog being used for actual investments

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3 ways to make sure this stock market correction is not wasted?

The stock market is falling! What do I do?

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The answer to this question can never be a precise one.

As we gain experience in the equity markets, the approach to handling market falls will slowly evolve for each one of us.

Now while I don’t claim have a perfect solution, here are few strategies which I believe can help us handle market falls in a much more sane manner.

1.When it comes to decisions, less is more

All of us know that, decision making is extremely tough during a market fall.

While the “What & How” part of the decision making has finally found some audience, unfortunately the equally important issue of when to make decisions is completely ignored.

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Given the reach of internet and mobiles, each and every day, every hour, every minute there is always some market related event, news or opinion out there. Add to the mix, that inevitable someone who is hell bent on scaring you with some conveniently handpicked data (sample this).

So, as the market fall continues, most of us get into the trap of constantly evaluating our portfolios and trying to make decisions on an as-and-when basis as new events/news/opinions keep bombarding us.

Each and every time the market falls, the honest truth is that we really have no clue if the fall will continue or the markets will bounce back. There are hundreds of variables determining the short run and it is impossible to predict how each and every one of them will interact together to determine the direction of markets.

So the key is not to look at each and every event/news/opinion as a reminder to take a decision!

In fact, the last thing we want to do, is to go unprepared into a falling market trying to take daily decisions based on the evolving events.

When it comes to decision making, less is more and hence we need to reduce the number of decisions to be taken. Most importantly we need to have a clear pre-decided plan on WHEN to take these decisions.

I personally use a 10% decision making trigger and have reduced my decision making points to less than five during a fall.

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  • Market falls by 10%?
  • Market falls by 20%?
  • Market falls  by 30%?
  • Market falls by 40%?
  • Market falls by 50%?

You can either use a common benchmark such as Sensex/Nifty or your own portfolio value for reference.

For eg, if you are using Sensex as reference, the maximum value was 38,645 (on 31-Aug-18)

So decisions will be taken at

  1. 10% fall ~ Sensex@35,000
  2. 20% fall ~ Sensex@31,000
  3. 30% fall ~ Sensex@27,000
  4. 40% fall ~ Sensex@23,000
  5. 50% fall ~ Sensex@19,500

In this way, I don’t need to look at the TV each and everyday trying to decide on what to do with my investments.

2.Pre-load your decisions with a what-if-market-falls plan

When we are calm and relaxed, we turn out to be extremely bad in imagining how we will act during times of emotional strain (think fear, anger, hunger, exhaustion, thirst etc).

Such an under-appreciation of how we behave during times of emotional strain is where the trouble actually starts.

How do you think you will behave if the market cracks by say 20%?

“I will of course buy more!” thinks the overconfident self.

But remember, this is you in your “cool & calm” avatar!

Your “emotionally charged” avatar might have different plans.. and if you are like the rest of us it will panic and freeze!

For more on this you can read my earlier post here

How do we solve for this?

We have an unusual person providing us the solution – Our friendly Starbucks Barista!

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In 2007, when Starbucks was going through a massive expansion, the company was opening almost 7 new stores every day and hiring as many as 1500 employees each week.

But this came with its own issues. The biggest amongst them was to train all the new employees to provide excellent customer service.

Unfortunately for most of the employees Starbucks was their first job and they had never dealt with an angry customer before. While they obviously wanted to a good job, however as soon as they started facing angry customers, a lot of them panicked, some lost their cool and few even snapped back at the customer.

Drawing on behavioral science, Starbucks came up with a simple solution – the “if-then” strategy. They added an extra page at the end of every employee handbook which had lines like, “If a customer yells at me then I will ______”. 

The employee would then write in advance what their response would be to this and other tough situations. It allowed employees to plan their response with a cool mindset, so they didn’t need to decide under pressure and risk losing their self control.

They also provided the employees with a simple decision making framework to apply:

The Starbucks LATTE System for Customer Service

  1. Listen to the Customer
  2. Acknowledge their complaint
  3. Take action by solving the problem
  4. Thank them
  5. Explain why the problem occurred

Now, instead of reacting with anger or panic, Starbucks employees had a clear game plan to deal with stressful situations.

Since the If-Then and the LATTE system was implemented, employee turnover had decreased, customer satisfaction was up and profits increased!

In essence, we also face a similar problem in a bear market as we go into one completely unprepared without a plan and overestimating our ability to handle the stress and panic.

So, let us apply the Starbucks technique to investing with our own “If-Then” plan.

  1. If market falls by 10% then I will..
  2. If market falls by 20% then I will..
  3. If market falls by 30% then I will..
  4. If market falls by 40% then I will..
  5. If market falls by 50% then I will..

Sounds extremely simple, but trust me, once you start thinking about this, you realize how difficult it is to decide even in normal times.

If you have an advisor this is probably a great time to sit together and chart out a plan. If you don’t have one, then make sure you write down your plan as it’s extremely difficult to think clearly in the middle of a falling market.

Also it serves as a reference to check how you thought you would behave during a fall (in your cool and calm avatar) vs how you actually behaved.

You can also check these two posts here (from the super-smart Morgan Housel) and here for getting a rough idea on how to build this plan.

3.Identify and keep a track of experienced investors

As humans we have a natural tendency to follow and conform with the crowd. You can read more about this here

Unfortunately, this tendency of social conformity is at its highest especially in situations of uncertainty.

So in uncertain periods like a falling market, the easiest and fairly intuitive option is to look around and follow the crowd.

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And unfortunately, as history has shown, the crowd usually panics at exactly the wrong time.

Now while the obvious solution is not to follow the crowd, it is far easier said than done. So instead of fighting this urge, we need to play along this urge.

I would suggest finding a group of experienced investors or fellow investors to discuss during times of panic. If this sounds difficult, you can take advantage of the internet and identify your “investors to track” list and follow them closely for their views and interviews.

Here are some people whom I personally track:

  1. Sankaran Naren – ICICI Prudential Mutual Fund
  2. Kenneth Andrade – Oldbridge Capital
  3. Rajeev Thakkar – Parag Parikh Mutual Fund
  4. Shyam Sekar – Ithought
  5. Kalpen Parekh – DSP Investment Managers
  6. Neelkanth Mishra – Credit Suisse

Now, by no way am I suggesting that we should blindly follow them. The idea is to carefully evaluate their views (given their experience and maturity) and take our own decisions.

Do let me know on what other strategies you use to stay sane during a market fall.

As always, happy investing!

You can follow Eighty Twenty Investor via Email (1 weekly newsletter) or Twitter

If you loved what you just read, you can check out all my other articles here

Disclaimer: All blog posts are my personal views and do not reflect the views of my organization. I do not provide any investment advisory service via this blog. No content on this blog should be construed to be investment advice. You should consult a qualified financial advisor prior to making any actual investment or trading decisions. All information is a point of view, and is for educational and informational use only. The author accepts no liability for any interpretation of articles or comments on this blog being used for actual investments