A Penny-Stock Trader’s Diary “Our Brains Are Hard-Wired To Get Us Into Investing Trouble”

Originally posted at The Idiot Tax blog,

I'd been watching the stock for at least a month. A small time oil & gas company in Africa. It managed to secure a huge land position for a company of its size. Looked very promising, well funded for some time. Management previously had success putting together a similar land position with another company before it was swallowed early. But, still highly speculative.This one wouldn't be dropping a drill on dirt until late 2014. Maybe 2015.

Being a stingy bugger and without a catalyst in the market, I kept sniffing around for a while before I finally slid my buy order in at 18.5 cents – this dude wasn't going to pay the current market price of 20 cents! Maybe even 18.5 was too much. When it dropped to 19.5, I began to believe my order would get filled, but then when it hit 19 cents my mind started to desert me.

"I could get this for 18 cents."

Volume. There wasn't a great deal of it. In fact it was being pushed down on mild trades. Someone needed a new flatscreen or wanted to get their kid Optimus Prime for Christmas. There was no prospect that enough shares would be dumped and I'd get my fill at 18 cents. The holding was tight and the sell side was thin. Regardless, I hit the amend button and my order dropped down the queue to 18 cents.

I assume you know where this story is going. You're probably wondering why I'm telling it when it inevitably makes me look like an idiot. So why tell? I've read countless explanations of investor psychology in a general sense, but rarely does anyone put their name to a calamity, or at least their nom de plume.

Everyone can recognise these paragraphs by Heidi Lefer and Ildiko Mohacsy, in Journal of the American Academy of Psychoanalysis and Dynamic Psychiatry, but there's little personality to it and no experience.

Economic bubbles and crashes have occurred regularly through history-from Holland's 17th century tulip mania, to America's 19th century railway mania, to the 1990s high-tech obsession. Though most investors regard themselves as investing rationally, few do. Instead they react collectively, buying high and selling low in crowds. Being subject to the illusion of control, they follow regressive behavior patterns and irrational, wishful thinking. They are victimized by their own emotions of hope, fear, and uncertainty.

When people feel doubt and panic, they regress to an earlier stage either individually or en masse. Under stress, they revert to affect (Mohacsy & Silver, 1980). Such mobbing has an obvious psychological counterpart in the market. Here, crowds are governed by wishful thinking. "Investors are coached to believe that a stock is a better buy when the price rises, that it's 'safer' to join the crowd in betting the price up and 'riskier' to buy a stock declining in price" (Vick, 1999, p. 7). Investors also join a crowd to minimize regret. If something goes wrong, they know others behaved the same way.

We recognise it when exuberance makes charts go vertically up or when stone cold fear pushes them ruthlessly down, but our ego inevitably makes us shy away admitting that we take part in any function of it – "that's those other sheep". We're merely unemotional observers, until we aren't. Is anyone going to admit they were buying in the final moments before the last bitcoin crash?

It was inevitable that a few short days after Wall Street lovingly embraced Bitcoin as their own, with analysts from Bank of America, Citigroup and others, not to mention the clueless momentum-chasing, peanut gallery vocally flip-flopping on the "currency" after hating it at $200 only to love it at $1200 that Bitcoin… would promptly crash. And crash it did: overnight, following previously reported news that China's Baidu would follow the PBOC in halting acceptance of Bitcoin payment, Bitcoin tumbled from a recent high of $1155 to an almost electronically destined "half-off" touching $576 hours ago, exactly 50% lower, on very heave volume, before a dead cat bounce levitated the currency back to the $800 range, where it may or may not stay much longer, especially if all those who jumped on the bandwagon at over $1000 on "get rich quick" hopes and dreams, only to see massive losses in their P&Ls decide they have had enough.

There will be a strange irony, in that anyone you talk to with a bitcoin experience will have left the building at $1100 – "it was looking bubbly, so I took a profit." Hmmm. The drip that bought at $1155 will be cloaked in anonymity, unless $2200 is later smoked.

Back to me, and the price my mind had agreed pay – 18.5 cents was hit. But where was I? Yeah, I'd cooly (or so I told myself ) shifted another gear down and was expecting to get my happy ending at 17.5 cents. As the share price firmed again, juddering between 19.5 and 20 cents I meekly snuck back to 18.5. At 20 I snuck up to 19, as I wondered whether it might go to 20.5. Of course it did, before coming back to 19.5, at which point I had enough steel to leave my order at 19.

In the midst of this circus, late on a Friday, the buy side appeared to firm considerably and immediately it looked a better buy again – "buy now and I'm with the crowd." After a fortnight of courting and several times being left with my frank in my hand, maybe it was time to make the move and just get my fill at 19.5. But, but, but, this was Friday afternoon and anything could happen over the weekend. Rating agency downgrades, terrorist attack, tsunami, nuclear disaster, alien invasion, apocalypse. And I'd still have to settle on Wednesday!

And something did happen. First it was a market announcement after the close on Friday that their seismic program had shown positive results. Damn, I assumed this was going to cost me another half cent! Then on Monday – TRADING HALT.

11 minutes before open on Monday morning. I spent most of Monday cursing my stupidity while muttering F-U under my breath. On Wednesday morning the announcement came out – an unsolicited equity placement at an 18% premium to the previous close. A significantly rare and positive event. And on open, the share begins trading at 23.5 cents.

Where's my order? Oh I'd moved it to 22 cents now. Sigh. Yeah it was happening all over again. Though a few price bumps up to 24 and 24.5 cents during the day had me edgy. Now the urge is to get ahead of the game because this is surely going higher.

What didn't help throughout this brain mincing was my constant contact with a share trading forum. Those great analogies that describe a share price ready for take off (see, I just used one then!) were flying into my eyes like poison darts. Common sense is blinded and it further makes me think I gotta get in!

Toot! Toot! Buckle up your seatbelts! The floor is in! A couple of cents will be meaningless soon!

Then there's also talk of the big boys buying, holidays (not just theme parks, your own private island), early retirement and Ferraris. Sitting on the sidelines and kicking yourself while reading this is a little unnerving, but a slap to the face and you quickly regain perspective. The real issue becomes the now moving share price. Even if you block out the chat room noise, with every half cent it's somehow a better investment – or speculation as it were. Yet last week every half cent movement downward made it waft like sun-baking salmon. Someone's selling, something must be wrong. Drag that order down so you won't overpay!

After again playing tag and miss with the price for most of the day, a gap opened up at 22.5 towards closing time. That was the entry point. No more mental gymnastics trying to second guess the next movement – if I got hit, I got hit. I placed my order. It sat near the top of the queue and with one foul swoop at 3:51pm I became a shareholder. A few minutes later the price went back to 23 cents and that's where it closed for the day. After two weeks of games, and being led around by my nose, it was a very painless exercise. Yet I had little control until I pinched my brain in those final moments. There was some satisfaction that I paid less than the premium placement that instigated the jump in price, but I still paid 21% more than if I'd just left my initial order 18.5 cents.

Again, from Heidi Lefer and Ildiko Mohacsy, in Journal of the American Academy of Psychoanalysis and Dynamic Psychiatry – I'm guilty as charged.

Our brains are hard-wired to get us into investing trouble; humans are pattern-seeking animals . . . .Our brains are designed to perceive trends even where they might not exist. After an event occurs just two or three times in a row . . . the anterior cingulate and nucleus accumbens automatically anticipate that it will happen again. If it does repeat . . . dopamine is released . . . .Thus, if a stock goes up a few times in a row, you can reflexively expect it to keep going up . . . .Brain chemistry changes as the stock rises, giving . . . a "natural high." You effectively become addicted to your own predictions.

At last close the share price sat at 31.5 cents. I'm in, I'm ahead and I'm finally calm. But I still can't believe how ridiculous my mental gymnastics became. I've got no clue how many trades I've completed over the years, but any time I'm buying a new company this farce reappears.

The share forums have gone wild over the company. Just by reading them the brain could start firing with thoughts of short changing your future family tree by not taking a position. I felt similar insanity that day I realised I'd be paying 21% more than I'd initially intended.

It's gone up consistently for weeks. It will keep going up, surely? No, I don't think that any longer, but that's the mental game any potential new entrant is faced with. Now, as a shareholder, I'm less concerned if it goes up or not. I just don't have to worry about being left behind if it does.

My terror now? The prospect of fighting my uncontrollable and irrational mind when it comes time to sell. Another two weeks to get an extra three cents, before eventually chasing the price two cents down?

If I can ruthlessly control my saving and spending, surely the same control can be applied to investing (or speculating).

Sooner or later I'll find out.