Building Your Investing Superpowers
Here’s a question: would you rather have a 95% chance to win $10,000, or a 100% chance to win $9,000?
Here’s another: would you rather take a 5% chance to lose $10,000, or a 100% chance to lose $600?
Write down your two answers. We’ll come back to them in a moment.
This little thought experiment is relevant, because the price of bitcoin’s going up again … and so are the number of bitcoin buyers.
This is significant for investors: it means that people follow price.
When the price of bitcoin is low, few people are interested. But once it starts breaking new records, the media starts buzzing about bitcoin again, and everyone wants in.
Here’s an easy visual: compare the historical price of bitcoin…
…with the number of people Googling “buy bitcoin”:
When the price goes high, people buy.
Most people buy high, then sell low, when they realize their terrible mistake. This, of course, is the opposite of how successful investors think, which is to buy low and sell high.
Let’s be honest: It’s no fun to buy digital assets when they’re “on sale.” When the price is low, no one’s excited about them, and it takes courage and conviction to buy more crypto.
Conversely, it’s easy to buy bitcoin when the price is skyrocketing, because it feels like the safe thing to do, like being part of a crowd pushing to get into an exciting event. It does not feel good to sell bitcoin when the price is going up.
To be a successful investor, though, that’s what we have to do. We have to swim against the crowd.
Easy to say, difficult to do. This is because it’s the opposite of how our brains are wired.
To be successful, we have to override our own brains.
The Ways Our Brains Fool Us
The classic book Thinking, Fast and Slow is a must-read for serious investors. Although it won the Nobel Prize in Economics, it’s really more of a book on human psychology: specifically, how we make decisions about money.
The book’s central idea is prospect theory, which describes how we look at wins and losses differently. Humans suffer from “loss aversion,” which means the losses feel bad, much more than the wins feel good. So we’ll go out of our way to avoid losses, even making irrational decisions.
The authors conducted many clever experiments on test subjects, like the two at the top of this article. Here are the mathematically correct answers, which you can compare with yours:
Would you rather take a bet with a 95% chance to win $10,000, or a 100% chance to obtain $9,000?
The “logical” answer is to take the 95% chance (since 95% × $10,000 = $9,500), whose expected payout is greater than the guaranteed $9,000. Many people take the guaranteed $9,000, which shows that we are risk-averse: we want to avoid that 5% probability of disappointment.
Would you rather take a 5% chance to lose $10,000, or a 100% chance to lose $600?
Again, the expected loss of the first choice is 5% × −$10,000 = −$500, which is better than the guaranteed loss of −$600. It’s the fear of a large loss ($10,000!) that makes us risk-averse, so we accept the greater guaranteed loss of -$600. The better answer is to take the 5% chance.
These are fascinating findings, and we see them playing out in crypto markets constantly. People make FOMO bets on brand new coins, with the hopes they’ll go to the moon — instead of making patient monthly investments into bitcoin.
But it’s not just loss aversion that has our brains working against us: it’s also the idea of the “hot hand,” or a gambler on a winning streak. This is why people are rarely able to hold on to sudden fortunes in crypto: they think it’s easy. “If I won once, I can win again.” Like a young sports star who spends his multimillion-dollar salary as fast as he makes it, it’s almost worse to win big, unless you have first experienced the pains of losses, and understand that both will happen.
There’s also the “gambler’s fallacy,” where people think, “we haven’t seen any sixes in a while, so a six must be rolled soon.” Well, the odds of a six on any given dice roll is still one in six. Doesn’t matter how long it’s been since a six was rolled, the odds are still one in six. We try to find patterns where there are none, and I don’t need to point out the huge number of crypto analysts who are themselves broke. They haven’t invested on their own analysis!
Even the biology of our brains can work against us. Dopamine gives us pleasure when the price goes up, reinforcing our “buy high” mentality in the short term. If that keeps up long enough, as Scientific American put it, the brain becomes “so awash in dopamine that it eventually adapts by producing less of the molecule and becoming less responsive to its effects.” In other words, it takes more and more risk to get the same “investor high.”
To sum up, we investors face three big challenges:
· Our brains want to follow the crowd, because it seems safer that way.
· Our brains make illogical choices, because losing feels worse than winning feels good.
· And our brains squirt chemicals that sometimes make us feel good for doing the wrong thing.
Fortunately, there’s hope. We can literally rebuild our brains.
Building Your Investing Superpowers
The first thing we can do is to make a decision to invest the same amount into bitcoin, every month. By dollar-cost averaging (we call it “steady drip investing”), some months you buy high, some months you buy low, but you always get the “average” price over time.
You can easily set up a service like Coinbase to auto-withdraw from your bank account each month, and invest it into bitcoin. (Whatever you can afford.) No more trying to guess the price, no more trying to time the market. You invest the money as you earn it … so your mind is free to do other things.
The other thing we can do is to gradually rewire our minds using meditation. Studies show that long-term meditators grow increased thickness on the outer folds of their brain (called gyrifcation). This results in “increased introspection, awareness, and emotional control,” according to Frontiers in Human Neuroscience, resulting in “integration of autonomic, affective, and cognitive processes.”
In plain English, this is like developing a superpower against the “gambler’s fallacy,” which is more prevalent in brains with the opposite characteristics. Meditation literally builds your brain, in a way that can make you a better investor. (For proof, see the brain scans above.)
We have released a new MP3 series called “Investor Mindset,” designed to build your brain in a fun and easy way. (Think of them like guided meditations for investors.) It’s a simple, step-by-step program to help you rebuild your brain. You can download the first three episodes here:
To outsmart your brain, invest the same amount, every month. To rebuild your brain, use our new training series. Together, these will give you investing superpowers. The science says so.
John Hargrave is the author of Blockchain for Everyone: How I Learned the Secrets of the New Millionaire Class, the bible of blockchain investing.