The way the stock market works is pretty simple to understand. In fact our biology dictates that it has to be. The brain you’re walking around with now is an unbelievably intricate tool that’s evolved and developed over hundreds of thousands of years, and is pretty much the pinnacle of all the models available on the showroom floor. If you wanted to invent fire by banging two rocks together then the human brain the only way to go. It is however, pretty much rubbish at handling really complex problems like the stock market.

That last sentence probably doesn’t sound right to you, which oddly enough is another reason your brain is really quite amazing. Your brain doesn’t have to completely understand anything; it only has to reach the point where it’s convinced that it does. This leap of creativity to fill in the gaps of the unknown is a real time saver and it won’t leave you standing around pondering things like “That kind of looks like part of the outline of a bear behind those bushes, but since I don’t see the whole bear there’s no need to worry yet”.

We know that the stock market is a massively complicated web of interrelated companies, economies, technologies and people, way too interconnected to know everything about it let alone how the movement of each piece affects the next. So let’s make it simple by filling in the gaps as best we can. Your brain can fill in these gaps in knowledge by using a few seamless tricks like using your memory of previous experiences to extrapolate and synthesize completely new bits of information. For example the Kanizsa Triangle (shown at right) does not actually display any complete triangles, though if you stare at it you can begin to see the complete outline of the white triangle as if it was a solid white piece of card laying on top of 3 black circles. The same principles are at play with the example of the incomplete outline of the bear mentioned above.

From a stone age perspective, remembering what happened in the past is the most reliable way to predict the future and this goes hand in hand with having evolved the ability to recognize patterns – even where none exist. This is why the stock market has to be simple to understand. We’d be paralyzed into inaction if we tried to comprehend every aspect of every trade that occurs, so we can simply reduce it to trends. The NASDAQ, S&P 500 and the DOW are lovely, simple indicators of the health of the overall market that’s easily digested.

The same thing can be applied to individual shares. A stock that’s been going up for the last year is really appealing to our brains, it’s an easy pattern to recognize, and an easy one to predict. It’s also where our biology lets us down. The pattern recognition is so strong, that it really is against our nature to believe that why something that’s always gone up could do otherwise.

Rivers always run down hill, it always gets cold in winter, wild bears will eat you. All great examples of pattern recognition, and prediction that confer an amazing survival advantage over every other species. Especially when you’re living in the Stone Age.

3 Steps to use a Stone Age Brain in an Information Age way

So now we have an idea of the limits we face with this bit of our brains’ biology, so how do we overcome it?

1) Accept that your brain lies to you and that it’s ok. We share the same brain as our Stone Age ancestors, but unlike them we can imagine that what we see may not be real.

2) Counter the natural inclination of your brain to take shortcuts with time. Don’t disregard your first impressions, feelings of fear or greed – they’re often right. We evolved these shortcuts for the reason that they usually work. Having said that, we’re not faced with ravenous bears that often and don’t usually need to make instant decisions. Take some time and apply point 1. A few minutes, an hour, even days, to ask yourself the question: Why did I initially feel this was a good/bad idea?

3) So how do you really understand the complexities of the stock market considering it’s influenced by a billion other Stone Age brains? Surprisingly this can be an advantage in understanding complex systems. If you recognize points 1 and 2 above then you know that everyone else’s brain has the same biological limits as yours and you can then try to predict how they might behave. With the stock market in particular this has developed into a rich research field, loosely dubbed neuroeconomics. Sadly there aren’t any easy ways to pick a sure thing yet, though several companies are trying.

Saying that we have a Stone Age brain sounds like an insult, but really it’s the opposite. The brain is such an amazingly complex piece of biology that to say we don’t know how it works is an understatement. What we do know about the biology of the brain and how it effects everything in your life is something we’ll revisit many times here at VeryEvolved.

But don’t worry, we’ll do it in simple chunks; so there’s no need for your brain to make things up to fill in the gaps.

Keep your Information Age brain updated with the latest reports by subscribing to our RSS or Email updates.

Original image webmb remixed by Patrick

January 8th, 2009