13 Nov 2014

THE SCIENCE BEHIND DECISIONS




The way we all make decisions is hidden deeply in the chemical activity of our brain. The chemical called dopamine is responsible for one of the most basic cravings in human life - being right.

As our brain is constantly analyzing and looking for patterns in literally EVERYTHING, whenever we make a right decision or find a pattern in something apparently random, our brain releases extra dopamine as a reward, which in turn make us feel pleasure. However - in situations when our expectations  and predictions are wrong -  we experience a sudden drop of dopamine levels in our brain and start feeling upset.

The anterior cingulate cortex (ACC) is the part of the brain involved in error detection. It helps remember what the dopamine cells have just learned, so that expectations can be quickly adjusted in light of new events. If you make a prediction ( for example - the EUR/USD is going down) but it doesn't happen - the ACC makes sure that the future predictions are revised. It generates predictions and then measures the difference between expectations and the actual results. This is essential aspect of decision making. If we can't incorporate the lessons of the past into our future decisions, then we are destined to endlessly repeat our mistakes.

For example - motion sickness is a result of a dopamine prediction error. There is a conflict between the type of the motion being experienced - for instance, the unfamiliar pitch of the boat - and the type of the motion expected (solid, unmoving ground). The result in this case is nausea and vomiting, but it doesn't take long before the dopamine neurons start to revise their models of motion - that is why seasickness is usually temporary.

Every time you experience a feeling of joy, happiness, fear or disappointment, your neurons are busy rewiring themselves, constructing a theory of what sensory clues preceded the emotions. The lesson is then committed to memory, so the next time you make a decision, your brain cells are ready. They have learned how to predict what will happen next.

The physicist Niels Bohr once defined an expert as "a person who has made all the mistakes that can be made in a very narrow field." From the perspective of the brain, Bohr was absolutely right. Expertise is simply the wisdom that emerges from cellular error. Mistakes aren't things to be discouraged. On the contrary, they should be cultivated and carefully investigated

And this is the reason why every trader needs a trading journal. We rarely learn anything from our winning trades. It's the losing ones that actually matter. When you are reviewing the mistakes you've made in any particular trade - you are actually cultivating dopamine levels in your brain, so they would adjust to the next time you are in a similar position again, so you wouldn't make the same mistake again.

Source: "How we decide" book by Jonah Lehrer

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