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The real culprit behind irrational financial decisions


In his book "Thinking, Fast and Slow," Daniel Kahneman, Nobel Prize-winning economist, has written, "you think with your body, not only with your brain."


Decisions taken by humans are affected by the biases and emotions that may distort our best rational judgment. All of our decisions are widely varied by factors like sleep, hunger, emotions, and other physiological factors. The decisions affected can be very general, like whether to talk to someone; or very complicated like a financial decision. The relationship between the financial system and emotions becomes more complex with time as the financial system evolves, but emotions don't.


Human brains are not rational computers; emotions play a vital role in this, and what controls human emotions is the hormones. Hormones guide the choices of humans and even their risk perception. Testosterone, the male hormone (found in females in minimal amount), is associated with aggressive behavior, confidence, competition, and optimism, whereas cortisol is connected with fear, risk-averse behavior.


If a person has a high level of testosterone, such as in a stressful or a competitive environment, then they will have higher confidence, and they will be more optimistic. For example, a person with a high testosterone level will place a high amount of trades at a high price, even in riskier assets. High-frequency trading, which involves significant amounts of money, is done by people who are confident about their trades and have a good understanding of the market. The person should be in a proper state of mind while placing the trades. Otherwise, they may end up making risky decisions.


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