Reptilian Decision-Making

Monday, 8 March 2021
Wollongong, Australia
By Greg Canavan

[8 min read]

It’s a public holiday in Victoria today. Another one.

But I’m in NSW. We’re not used to downing tools so regularly up here. (Said only slightly tongue-in-cheek.)

So despite the office being closed, I’ve got something interesting for you. It’s an excerpt from my new book. Subscribers to my new service, Greg Canavan’s Investment Advisory, can get access to all 10 chapters via the Special Reports section of the website.

If you’re interested in the new service, go here.

For now though, an excerpt from the book. It’s about how we often let our emotions get the better of us. It’s a key theme of the book. Rest assured though, it happens to everyone (as you’ll see below).

The pros are just a little better at self-awareness and making sure what happens once doesn’t happen over and over. My book shows you how you can do this too.


I want to tell you a story. It’s about a famous trader who panicked and lost millions. But the deeper meaning behind it could help you make much better decisions with your money right now, in 2021.

I want to tell you this story to show you that, when it comes to investing, we are all in the same boat. Professionals and amateurs alike must grapple with their emotional impulses.

As a general rule, I would say that professionals are better at this than amateurs or do-it-yourself investors, only because they’ve been in the game longer. They made the mistakes and have had to recognise and correct them to stay in the industry.

But that doesn’t mean they don’t continue to succumb from time to time, as the following story will show you…

The big trader with the mammal brain

In 1987, stocks around the world had been in a roaring bull market for years. From the 1982 lows to the 1987 peak, the US S&P 500 was up 230% while Japan’s Nikkei had advanced a massive 290%.

During the advance, a little-known trader (at the time) called George Soros began to get nervous. He thought global markets were primed for a fall, led by Japan’s Nikkei.

So he put on a ‘short Nikkei’, ‘long S&P 500’ trade, meaning he thought Japanese stocks would lead the falls while the US market would continue to advance.

Unfortunately, he was wrong.

The S&P 500 topped out in August 1987, before crashing in October. The Nikkei, on the other hand, was much more resilient. It peaked in October, didn’t fall as much as US stocks, and recovered much quicker.   

This was the opposite of how Soros thought it would play out.

While Soros wasn’t well known by the general public in 1987 (this was before he ‘broke the Bank of England’), he was well known on Wall Street for the size of the bets he placed. In other words, he didn’t muck around. If he liked a trade, he bet big.

Long and wrong

But he got this one wrong. Apparently, he was long 2,400 S&P 500 futures contracts, meaning he had a huge leveraged bet on US stocks going up.

On Monday, 19 October 1987, the S&P 500 plunged 20.5%. While that day gets all the headlines, it was what happened a few days later that is even more incredible. Yet hardly anyone knows the story.

Following Monday’s infamous crash, the market recovered slightly. On the Tuesday evening, the S&P futures closed on their highs. This is usually a good sign for the following day’s trading. Indeed, the market jumped nearly 10% in Wednesday’s trading.

However, on Wednesday night, the futures market ‘gapped down’. This means there was a gap between the opening price and Wednesday’s closing price. But it wasn’t just a gap. It was a chasm. Get this: The difference between Wednesday’s physical market closing price and the futures market’s opening price was 23%! That’s more than what the S&P 500 fell on Black Monday!

History’s forgotten this because it happened in the futures market and was all over very quickly.

What caused the gap down?

Remember how I said Soros had a massive long position? Well, he wanted to get out. And everyone on the trading floor knew it. The sell orders started at 9:30am on Thursday. Given the strong close on Wednesday, Soros assumed he could exit into strength. Still, Soros (at least traders assumed it was Soros) offered contracts for sale at 240 points on the S&P 500. This was 7% below Wednesday’s close of 258.

The traders on the floor smelled blood. They knew there was a big and desperate seller.

There were no bids…

And so the offer price kept falling…and falling. All the way down to 200. And still no bids! The first bid came in at 198, 23% below Wednesday’s open! Soros was in a panic and the sharks started circling.

Those traders who were short the market (the ones that had placed bets on a market decline) started buying to cover their positions. They bought Soros out within minutes, making millions in the process. The short covering saw the market recover. Within two hours, the S&P 500 was back above 250.

Soros was completely savaged. He lost hundreds of millions in less than five minutes. If you look back on the historical price charts, the Thursday morning panic doesn’t even show up. The plunge and recovery happened so quickly it didn’t even register in the physical (non-futures) market.

What happened?

Well, I’ll come back to that. But I want to pause here to dig into why I’m telling you this story in the first place. See, Soros has gone down in history as one of the world’s great traders. But that doesn’t mean he got it right every time. He didn’t.

And he doesn’t have better ‘hardware’ than you or I do, either. His brain is wired pretty much the same as ours. Becoming a great trader is as much about managing your brain — your fears, biases and emotions — as anything else.

In fact, I’d say this is THE defining factor in investment success. You can’t control the markets. But you CAN control your response to them. Get that right and success will follow, I believe.

See, your brain is a fabulously complex thing.

It has an ancient, or reptilian, brain that controls basic, life-generating functions like heart rate and breathing. It keeps you alive without you having to think about it.

Then there is your mammalian brain (also known as the limbic system), which controls your emotions, stores all your memories, and basically runs all of your subconscious behaviour.

On top of this is the cortex; the thinking, reasoning you. The cortex gives you the qualities that make you uniquely human.

It’s how these three systems work together that matters. And unfortunately, the brain has not evolved to deal with investment markets. That’s why so many investors lose when they first start out. Not because they pick the wrong stocks, but because they succumb to emotional pressures, which are the result of our innate software program that runs in the background.

In her book, I, Mammal, Dr Loretta Breuning writes:

Humans have a big cortex and a big capacity to learn from experience. But we cannot short circuit our mammalian limbic system. Our cortex gives our limbic system information to make better decisions, but our limbic system still controls the neurochemicals that link mind and body. Our actions ultimately come from our neurochemical selves.

In other words, our brains — reptilian, mammalian and cortex — impact how we think and feel. Not in a vague sense — but in a measurable, chemical sense. If we’re scared or excited, our body will be flooded with chemicals that change how we feel. And that has big investment implications.

As Jason Zweig explains in Your Money and Your Brain:

Traumatic experiences activate genes in the amygdala, stimulating the production of proteins that strengthen the cells where memories are stored in several areas of the brain. A surge of signals from the amygdala can also trigger the release of adrenaline and other stress hormones, which have been found to “fuse” memories, making them more indelible. And an upsetting event can shock neurons in the amygdala into firing in synch for hours — even during sleep. (It is literally true that we can relive our financial losses in our nightmares). Brain scans have shown that when you are on a financial losing streak, each new loss heats up the hippocampus, the memory bank near the amygdala that helps store your experiences of fear and anxiety.

The amygdala seems to act like a branding iron that burns the memory of financial loss into your brain. That may help explain why a market crash, which makes stocks cheaper, also makes investors less willing to buy them for a long time to come.

It makes sense, doesn’t it?

When the market falls, your brain interprets it in the same way it would a physical threat. It releases stress hormones to enable you to deal with the threat. But in a 2008 or 2020 type environment, where the market falls relentlessly, the stress of dealing with that becomes unbearable.

This is why you often sell at or near the bottom. The strain is just too much and the only way of relieving the stress is to sell.

Once you sell, your amygdala calms down and your adrenal glands get a rest. This allows your cortex back into the conversation and, by this time, the market may have bounced. Because the cortex is back in control, this is when you kick yourself for selling at the bottom. You feel stupid.

But if the experience was traumatic, like it was in 2008 or 2020, your amygdala has such vivid memories that it can override your reasoning, rational cortex for some time.

You know stocks are cheap. You know that buying when others are fearful is the ‘right’ thing to do. But your fear centre holds you back. It still thinks it’s unsafe. It’s worried about further falls.

It’s only when the fear starts to recede, often years later, that investors go back into the market.

This is why stock markets are a largely psychological phenomenon. They are as much about human emotions (driven by the limbic system) as they are about fundamental factors such as company earnings, economic growth and interest rates.

And it’s why markets move as they do. We’re often too fearful to buy stocks when they’re cheap, too slow to sell when they fall, and too driven by what other people are doing and saying.

But look. What does any of this have to do with right now?

A lot.

Making the right decisions with your money right now means overcoming all sorts of psychological biases. There’s the fear of last year’s market crash lurking in the back of your mind. There’s the fact that the world economy has taken a massive hit — and the pandemic isn’t over.

Contrast that against rapidly rising markets in which everything seems to be going UP…and throw in near-zero interest rates for a little added spice…and you have a pretty confusing and volatile picture.

And it’s made worse by the fact that doing nothing isn’t really an option, either. In times gone by, you could sit in cash, earning 6–7%, and wait things out. But not this time. Rates are pinned to the floor everywhere — and will likely remain so.

In other words…the stakes have never been higher.

But all that said, there is hope. And that’s what my Life at Zeroevent is really all about — showing you that, despite all the challenges you face, you can come out of this on top. You can get ahead. If you have a clear plan and an experienced guide, the next few years could be very prosperous.

You can click here to view the event right now…

But before I go…

What happened to Soros?

Did he lose his nerve? Did he panic? Did his amygdala hijack his cortex and press every fear receptor in his body?

It certainly sounds like it.

Think about it. He was very long S&P 500 Futures when they plunged 20% on Black Monday. That event alone would have rattled him. Sometimes you just have too much money on a position to ever be able to think clearly about it, no matter who you are.

Black Monday was a day of shock and fear, especially if you were long. Soros’s amygdala would’ve been scarred from it. He would have had cortisol coursing through his veins. After a couple of days and near sleepless nights, the fear would still have been palpable. His one thought, I’m sure, was: ‘I can’t let that happen again. Another fall like that will ruin me.’

Remember, your body’s basic instinct is to survive. Survival above all else. And when you’re in survival mode, the mammal brain takes over.

Soros knew his survival as a trader was at stake. Not his physical survival, of course. But the brain doesn’t distinguish. Survival is survival — end of story.

So after sleeping on it for a few nights (or more accurately, probably not sleeping), Soros wanted out. He wanted to end the pain. Not only the pain of the losses inflicted so far, but the perceived pain of being completely wiped out. And being long the S&P 500 threatened to wipe him out.

So he got out in a panic, and paid the price.

One of Soros’s traders at the time, Victor Niederhoffer, recounted the survival aspect of this story in an interview with Bloomberg’s Barry Ritholtz in September 2017:

No one in the world has a better instinct for survival than [Soros] does. I remember during the October 1987 crash, on Thursday October 22, he sold all of his stocks…just liquidated them at the open. He made so many traders on the floor of the mercantile exchange multimillionaires with that trade. But, it occurred to him that he could face destruction and he did what he had to do — he liquidated his entire position, took a huge loss, thinking that survival was more important than anything else.

As it turned out, Soros sold at the low.

Even the greatest get it wrong sometimes. Though Soros learnt his lessons the hard way. And he’s now widely regarded as one of the greatest traders of our time.

Good investing,

Greg Canavan,
Editorial Director, Port Phillip Publishing

[WATCH] Tech Bargain Hunting

By Murray Dawes

With bonds continuing to sell-off and tech stocks taking plenty of heat, I reckon it’s time to consider which tech stocks you really want to own long term.

If the correction gathers steam there may be some great bargains to be had.

In today’s ‘Week Ahead’ update, I look at one such stock that is a market leader in its field.

They are growing revenues rapidly, but their costs are also growing quickly as they make a land grab for market share.

They have been making some clever bolt-on acquisitions, which adds depth to their offering, but the market seems to be tiring at the lack of visibility about when they will be cash flow positive.

This stock is incredibly volatile, but it is trending in the right direction.

If US bonds continue to sell-off and tech stocks continue to get pummelled, this stock could fall to levels that will be seem like a bargain in a few years’ time.


Murray Dawes Signature

Murray Dawes,
Editor, Pivot Trader