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.

walter-bradford-cannon-ab4507f0-5dff-4add-824f-28817fe46e7-resize-750.gif

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

LeDoux_Joseph_web1.jpg

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!

Image result for lab mice

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!

amygdala-banner.jpg

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)

high-low-road.jpg

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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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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Author: Arun

Hey! I'm Arun and I work for the research team of a boutique wealth management firm based out of Chennai. The idea behind this space is to share some of my learnings/mistakes and hopefully be of some help to you in making better investment decisions :)

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