Posted by on Dec 10, 2017 in Articles & Advice, Blog, Featured, Posts |

By Jason Zweig  |  Dec. 10, 2017 9:43 a.m. ET

Image credit: Jean-Baptiste-Simeon Chardin, “Soap Bubbles” (ca. 1733-4), National Gallery of Art


As far as I can tell, this essay, which I wrote in 2003 as an invited contribution to a monograph called “Boom and Bust: Why Did It Happen and What Can We Learn from It?” published by the European Asset Management Association in London, isn’t available online. I probably wouldn’t write it quite the same today — I would place much more emphasis on the role of institutional investors, who inflated the bubble at least as much as individual investors did — but I thought I should post it anyway to restore it to the public record. I’ve Americanized some spellings and added more paragraph breaks, just for ease of reading.


Benjamin Graham, the Human Brain, and the Bubble

Jason Zweig

At the peak of every boom and in the trough of every bust, Benjamin Graham‘s immortal warning is validated yet again: “The investor’s chief problem — and even his worst enemy — is likely to be himself.”1Benjamin Graham, The Intelligent Investor, updated edition revised by Jason Zweig (HarperCollins, 2003), p. 8. Indeed, the distinguishing characteristic of the growth-stock bubble of the late 1990s was that the Internet made it so easy for investors to pick their own pockets, instead of paying someone else to do it for them.

Disintermediation — the bypassing of middlemen like bankers and “full-service” brokers — had been underway for decades. But it reached near-perfection in the bubble years. Discount brokers like Charles Schwab arose in the 1970s, then mushroomed in the 1990s, enabling investors to cut out the traditional (and more costly) face-to-face relationship offered by firms like Merrill Lynch and Smith Barney. Index funds, run by faceless machines, dispensed with the notion of hiring a “superstar” to pick stocks. Mocking the very idea that professional portfolio management was worth having in the first place, popular websites like the Motley Fool incessantly pointed out that more than 90% of all U.S. stock funds had underperformed the Standard & Poor’s 500 index in the late 1990s.

Online trading firms went further, blowing the traditional brokerage model to bits. With no physical branch offices, no in-house research, no investment banking, and no brokers, they had only one thing to offer their customers: the ability to trade at will, without the counterweight of any second opinion or expert advice. Once, that degree of freedom might have frightened investors. But the new Internet brokerages cleverly fostered what psychologists call “the illusion of control” — the belief that you are at your safest in an automobile when you are the driver. Investors were encouraged to believe that the magnitude of their portfolio’s return would be directly proportional to the amount of attention they paid to it — and that professional advice would reduce their return.

“If your broker’s so smart,” heckled an advertisement from an online trading firm, “how come he’s not rich?” Another brokerage advertisement featured a photo of a dazed-looking chimpanzee and the headline “Chimp beats Wall Street wizard for second straight year.” The text of the advertisement continued: “And you’re worried about investing on your own? You shouldn’t be. Just click on e*Trade and see how easy investing online really is.”2Advertisement for e*Trade, SmartMoney magazine, July 1998, p. 11.

Easy, indeed: a televised advertisement for Ameritrade showed two suburban housewives coming into the house after jogging. One trotted over to her computer, clicked the mouse, and burbled, “I think I just made $1,700!”

For years, Peter Lynch, the renowned manager of the Fidelity Magellan fund, had been urging investors to “buy what you know.” His notion was that amateur investors, merely through their normal consumption of products and services, could get a special insight into which companies would grow fastest in future. Lynch claimed, for instance, that he bought Taco Bell partly because he liked the food and Consolidated Foods (now Sara Lee Corp.) because his wife liked L’eggs pantyhose.

The internet took this principle, which was already intuitively appealing to individual investors, and made it seem irresistible. A small investor back in 1999 who was interested in reading a book about day trading would naturally go online to search for, and buy, the book at Then, after reading it, he might log back on and begin trading on Among the stocks he most likely would have bought first were and Charles Schwab Corp. So there he was: using the Internet to learn about buying Internet stocks over the Internet. Better yet, it worked — and “I did it all myself!” Never before had the Peter Lynch Principle seemed so seductive — and successful.

Next, our online trader found that he was not alone. Psychologist Marvin Zuckerman at the University of Delaware has written about a form of risk called “sensation-seeking” behavior. This kind of risk — people daring each other to push past the boundaries of normally acceptable behavior — is largely a group phenomenon (as anyone who has ever been a teenager knows perfectly well). People will do things in a social group that they would never dream of doing in isolation.

And the new online traders who posted their ideas in online bulletin boards like egged each other on as individual investors had never before been able to do. Until the advent of the Internet, there was simply no such thing as a network or support group for risk-crazed retail traders. Now, quite suddenly, there was — and with every gain each of them scored, they goaded the other members of the group on to take even more risk. Comments like “PRICE IS NO OBJECT” and “BUY THE NEXT MICROSOFT BEFORE IT’S TOO LATE” and “I’LL BE ABLE TO RETIRE NEXT WEEK” became commonplace.

What’s more, this kind of network was inherently self-selecting: the most aggressive bulls tended to post the loudest and the most often, making their success seem characteristic of the group as a whole. Base rates alone — in a rising market, winning stock trades are everywhere — made these people seem “right.” Even though they rarely offered any logical analysis to justify their stock picks, performance claims like “UP 579% IN FOUR MONTHS” gave these online stock touts an almost hypnotic power.

And the public was urged to hurry. “EVERY SECOND COUNTS,” went the slogan of Fidelity’s discount brokerage — implying that investors could somehow achieve their long-term goals by engaging in short-term behavior.

Thanks to the wonders of electronic technology, stocks became visual objects, almost living organisms: For the first time in financial history, you could buy a stock and track its price movements in real time, following along on your computer monitor as it twitched and ticked its way up. You could watch your wealth grow before your very eyes — another manifestation of the illusion of control. As Kathy Levinson, the president of e*Trade, told The New York Times in late 1998: “There’s more confidence and comfort when you can see your stock and watch it move.”

But something else was going on here. Not long ago, an individual investor could track stock prices only by telephoning her broker, visiting a brokerage office that had a stock ticker, or waiting to read the stock-market listings in the next morning’s newspaper. No longer was an entire day’s activity summed up in a stupefyingly dull single line of numbers in a newspaper like “40.43 +.15  47.63  30.00  0.6  23.5  1959.” Instead, in the 1990s, stock pricing went real-time: animated, visual, and ever-changing. A rising stock generated a warm green arrow; a falling stock flared onto the screen as a scalding red arrow. Every trade showed up as another tick on the day’s rising or falling line of prices; every few ticks appeared to generate a “trend.”

By using technology to turn investing into a video game — lines snaking up and down a glowing screen, arrows pulsating in garish hues of red and green — the online brokerages were tapping into fundamental forces at work in the human brain.

In 1972, Benjamin Graham wrote:

“The speculative public is incorrigible. In financial terms it cannot count beyond 3.  It will buy anything, at any price, if there seems to be some ‘action’ in progress.”3Graham, The Intelligent Investor, pp. 436-437.

In a stunning confirmation of his argument, the latest neuroscientific research has shown that Graham was not just metaphorically but literally correct that speculators “cannot count beyond 3.” The human brain is, in fact, hard-wired to work in just this way: pattern recognition and prediction are a biological imperative.

Scott Huettel, a neuropsychologist at Duke University, recently demonstrated that the anterior cingulate, a region in the central frontal area of the brain, automatically anticipates another repetition after a stimulus occurs only twice in a row. In other words, when a stock price rises on two consecutive ticks, an investor’s brain will intuitively expect the next trade to be an uptick as well.

This process — which I have christened “the prediction addiction” — is one of the most basic characteristics of the human condition.4The emerging field of financial neuroscience (or “neuroeconomics”) is surveyed in Jason Zweig, “Are You Wired for Wealth?” Money Magazine, October, 2002, pp. 74-83, also available online at: and Automatic, involuntary, and virtually uncontrollable, it is the underlying neural basis of the old expression, “Three’s a trend.” Years ago, when most individual investors could obtain stock prices only once daily, it took a minimum of three days for the “I get it” effect to kick in. But now, with most websites updating stock prices every 20 seconds, investors readily believed that they had spotted sustainable trends as often as once a minute. No wonder stocks like Puma Technology saw their entire share base turn over every six days.5Graham, The Intelligent Investor, p. 38.

Another neuroscientific finding bolsters Graham’s case. Teams of brain researchers around the world, led by Wolfram Schultz at Cambridge and Read Montague at Baylor in Houston, Texas, have shown that the release of dopamine, the brain chemical that gives you a “natural high,” is triggered by financial gains. The less likely or predictable the gain is, the more dopamine is released and the longer it lasts within the brain. Why do investors and gamblers love taking low-probability bets with high potential payoffs? Because, if those bets do pay off, they produce an actual physiological change — a massive release of dopamine that floods the brain with a soft euphoria. Experiments using magnetic resonance imaging [MRI] technology have found an uncanny similarity between the brains of people who have successfully predicted financial gains and the brains of people who are addicted to morphine or cocaine. After a few successful predictions of financial gain, speculators literally become addicted to the release of dopamine within their own brains. Once a few trades pay off, they cannot stop the craving for another “fix” of profits — any more than an alcoholic or a drug abuser can stop craving the bottle or the needle.

A losing stock trade, however, sets off an entirely different response in the human brain. No one put it better than Barbra Streisand, the Hollywood-diva- turned-day-trader, who told FORTUNE Magazine in 1999: “I’m Taurus the bull, so I react to red. If I see red [on a market display screen], I sell my stocks quickly.”6Graham, The Intelligent Investor, p. 39.

Neuroscientists have shown that the amygdala, a structure deep in the forward lower area of the brain, reacts almost instantaneously to stimuli that can signal danger. The amygdala is the kernel of hot, fast emotions like fear and anger — the seat of the “fight or flight” response. Evolution developed the amygdala to be the early warning system of the human brain, the elemental circuitry that first alerts us to the presence of physical risk. Vivid sights and sounds — clanging bells, hollering voices, waving arms, or menacing colors — set off the amygdala. If a fire alarm goes off in your office building, you will break out in a sweat and your heart will begin racing — even as your “conscious mind” tells you it is probably a false alarm.

Using MRI scans, leading brain researchers including Jordan Grafman at the National Institutes of Health and Hans Breiter of Harvard Medical School have shown that the more frequently people are told they are losing money, the more active their amygdala becomes. There can be no doubt that online trading, by displaying stock prices in a dynamic visual format that can directly activate the fear center of the brain, made losing money more viscerally painful than it had ever been before. Once the arrows turned red, investors could not help but panic. And the red arrows were everywhere: on their computer screens and financial television programs in pubs and restaurants, bars and barbershops, brokerage offices and taxicabs. Investors no longer had the option of simply not opening the newspaper. Technology had turned financial losses into an inescapable, ambient presence.

What would Graham advise us in the aftermath of the bubble? I think he would warn us that harsh regulation creates a dangerous illusion that the markets have now been made safe for investors. No reform can ever eradicate the certainty that investors will, sooner or later, get carried away first with their own greed and then with their own fear. Human nature is immutable. Whether we like it or not, the financial future will suffer regular outbreaks of booms and busts. Like the bubonic plague, SARS, or swine flu, we shall never be able to predict exactly when they will arrive or just when they will end. All we can know is that they will remain inevitable as long as markets themselves exist.

The only legitimate response of the investment advisory firm, in the face of these facts, is to ensure that it gets no blood on its hands. Asset managers must take a public stand when market valuations go to extremes — warning their clients against excessive enthusiasm at the top and patiently encouraging clients at the bottom. They should ensure that none of their portfolios are ever marketed on the basis of short-term performance. They should close their “hottest” portfolios precisely when they are hottest, lest a flood of new cash swamp their performance. They should communicate continuously, forthrightly, and as personally as possible with all of their clients in order to build an enduring emotional bond that can survive the next boom and the ensuing bust.

Long-term survival is most certain for the asset-management firms that can look back, with 20/20 hindsight, and establish with a clear conscience that they conducted themselves with perfect honor — no matter how extreme the market’s mood swings may have become.



Additional resources:



Terrance Odean, “Advertising to Investors” (online finance class featuring clips from discount-brokerage commercials during the Internet bubble)



Benjamin Graham, The Intelligent Investor

Jason Zweig, Your Money and Your Brain

Jason Zweig, The Devil’s Financial Dictionary


A Note on Benjamin Graham

From the Archives:

Is Your Brain Wired for Wealth?

When the Stock Market Plunges…Will You Be Brave or Will You Cave?

Lessons and Ideas from Benjamin Graham

Has There Ever Been a Better Time to Be an Investor?

Best Books for Investors: A Short Shelf