This article is excerpted from "The Investment Paradox" Chapter Three "Greed" by Jason Zweig.

Why can good news be so bad?

One of Wall Street's oldest maxims is: "Buy on the rumor, sell on the news." The theory behind this cliché is that when smart investors generally believe something significant is about to happen, the stock market rises. Then, once the public learns of this good news, savvy investors will sell at a High Stock Price, causing stock prices to drop.

This makes some sense, but it may have more to do with the expectation circuits in everyone's brain rather than the extraordinary mental acuity of a few large investors. Celera Genomics Group is a vivid example, as the company's stock price soared due to hope but fell due to reality. On September 8, 1999, Celera began sequencing the human genome. By identifying the 3 billion base pairs that make up human DNA one by one, the company could achieve one of the biggest leaps in Biotechnology history. As Celera's dazzling venture began to attract attention, investors were filled with anticipation. In December 1999, Eric Schmidt, an Analyst for Biotechnology Stocks at SG Cowen, summarized the market's mindset: "Investors were enthusiastic about this Industry, hoping that today's story can drive tomorrow's economy." Celera's stock price skyrocketed from $17.41 at the beginning of the sequencing project to a High Stock Price of $244 in early 2000.

On June 26, 2000, during a grand press conference at the White House (attended by then-President George W. Bush and UK Prime Minister Tony Blair), Celera's chief scientist J. Craig Venter called it "a historic moment in human history of 0.1 million years": the company had cracked the human genetic code. However, how did the stock react to this official news? It plummeted! Down 10.2% that day, and another 12.7% the next day.

Nothing made the company's fate worse. On the contrary, Celera achieved a scientific miracle. So, why did the stock market crash? The most likely explanation is simple: the fire of expectations can be easily doused by the cold water of reality. As soon as the long-awaited good news was released, the excitement faded. The resulting emotional vacuum was almost immediately filled with a painful awareness that the future would not be as exciting as the past. As Yogi Berra famously said: "The future ain't what it used to be." Getting what they wanted left investors with nothing to look forward to, so they exited, and the stock crashed.

By the end of 2006, Celera's stock (one of two stocks under the company Applera) was about $14, over 90% lower than its historical peak. This indicates that if a company's greatest Asset is investor greed, then buying its Stocks can be very risky.

Memory is forged by money.

German researchers tested whether expectations of economic benefits could improve memory in a remarkable experiment. Neurologists scanned people's brains with magnetic resonance imaging while showing them images of objects like hammers, Autos, or grapes. Some images were paired with opportunities to win half a euro, while others had no rewards associated. Participants quickly learned which images had reliable links to earning money. The magnetic resonance imaging showed that when these images appeared, people's expectation circuits were triggered vigorously.

Immediately afterward, researchers presented participants with a larger set of images, including some that had not been shown in the scanner before. People could accurately distinguish the images they had seen in the previous experiment. They were equally adept at identifying which of these images predicted economic gain and which were unrelated to it.

Three weeks later, participants returned to the lab. There, they saw these images again. However, a surprising thing happened this time: despite not having seen these images for 21 days, they were better able to distinguish between images that indicated economic benefits and those that did not. This finding shocked researchers, who went back to re-examine the scan results from three weeks ago. The results indicated that the images associated with potential rewards not only activated the expectation circuits but also sparked stronger activity in the hippocampus, which is responsible for long-term memory.

The initial fire of expectation seems to have imprinted memories of potential rewards more deeply into the brain. Neurologist Emrah Duzel stated, "For the formation of memory, expected rewards are more important than received rewards." Once you understand that gambling can yield profits, you remember the environments and expected stimuli more clearly and more durably. Just as artists use spray to stabilize colors, expectation acts like a fixative for memory, ensuring that memories of obtaining rewards do not fade over time.

Peter Shizgal, a neurologist at Concordia University in Montreal, mentioned that for some people, the memory of that good feeling can overshadow other more important financial information. He told a story: "A psychologist I know had a patient with a compulsive gambling problem, and one weekend this patient won about 0.1 million dollars. He asked the patient, 'What is your net gain or net loss?' The patient said, 'I lost 1.9 million dollars; I invested a total of 2 million dollars and ultimately won 0.1 million dollars!'" Shizgal explained, "The first part of his answer was completely devoid of emotional content. This part is the important information, but it had no impact on him. Only the fact that he won money was truly unforgettable, and that would continue to control his behavior."

No wonder many of us focus on those highlights that can rival Warren Buffett when reflecting on past investments, while our actual investment records are filled with mistakes and losses. Because expectations of return help us remember our gains, even investments with a 20% success rate can still evoke pleasant feelings when looking back.

As shown by the experiments of Little Wild Boar, expectations seem to divide into two phases: the first phase is a review of memories, and the second phase is filled with hopeful anticipation. This explains why Laurie Zink had never bought a lottery ticket before winning on a reality show but afterwards fell in love with playing the lottery; it also explains why Mark Twain, despite being wealthy, always wished to make a fortune.

Control your greed.

How can the brain's expectation circuit avoid financial difficulties? First, one must realize that the expectation circuit can get out of control; that’s just how it works. Therefore, if the rest of your brain does not check these expectations, you will end up chasing every hot trend that erupts in front of you. In the long run, you gain nothing but risks and losses. The strategies below can teach you how to do better.

➢ On Wall Street, the only certain thing is that everything is uncertain.

Remember, your search system is driven by the feeling of making a fortune, which hinders your ability to calculate the probability of getting rich. Be wary of those who try to lure you into traps with clichés like "double your wealth", "endless potential", and "it’s really going to rise". The higher the expected ROI of an investment, the more questions you should be asking. Start with this question: why is the person who knows about this great investment willing to share the secret with others? Then ask yourself this question: why did this rare investment opportunity happen to fall into my lap? Also, never—I repeat, never—invest based on a cold call from a broker you have never met. Say "no" and hang up. Never—I will say it again—reply to a spontaneous email encouraging you to invest; just delete it without opening.

➢ Luck rarely favors you twice.

If you have ever tasted the sweetness of sudden wealth, you will likely want to spend the rest of your life trying to reclaim that feeling. It’s easy to find stocks that have risen in the past, but much harder to discover those that will continue to rise in the future. Be particularly wary of stocks that remind you of ones you made money on long ago, as any similarity to those stocks may be pure coincidence. Only after thoroughly researching the fundamental business behind a stock should you consider investing heavily, and even if the stock market takes a vacation for 5 years, you should be happy to hold onto it.

➢ Lock away your "emergency money" and throw away the key.

If you cannot prevent yourself from taking risks in the market, at least limit your risk level. Just like a gambler locks their wallet in the hotel safe and only brings $200 to the casino to limit potential losses, you should also set a cap for speculative trades. Invest at least 90% of your funds in low-cost, diversified index funds that cover all categories of stocks in the market. The maximum proportion for speculative trading should be 10%. Ensure your "emergency money" is completely separate from your long-term investments; never mix them together. Regardless of how much it rises or falls, never increase your bets on a speculative account. (It’s especially important to resist the temptation to increase your bets when your trading conditions are favorable.) If a speculative account incurs losses, shut it down.

➢ Resist the temptation of suggestions.

In Pavlov's experiment, the dog would salivate at the sound of the bell, just as an alcoholic craves a drink upon hearing the sound of beer being poured into a Glass from the other side of the room. Likewise, the stock market continuously emits signals, tempting you to enter. Psychologist Howard Rachlin from Stony Brook University points out that the first step to quitting smoking is to attempt to smoke the same number of cigarettes each day. This gives a clue: the fewer greedy opportunities there are, the smaller the expected satisfaction, and thus, the stronger your self-control becomes. Brian Knutson suggests asking yourself: how can the environment be cleared? (Think of someone trying to quit smoking who hides all the ashtrays.) How to reduce exposure to more cues? Try turning off financial news on television so there won't be any clamor about stock market trends that distracts you from long-term financial goals. Alternatively, if you find yourself passing by the local stock brokerage daily and can’t resist peeking at the stock quotes on the electronic ticker through the window, take a different route. If you find yourself obsessively checking stock prices online, use the browser's history window to count how many times you check stock prices each day; this number might shock you. The first step to reducing your queries is to know how frequently you check them daily.

To control the temptation of suggestions, another simple and effective method is to list a checklist of criteria that must be met before you Buy or Sell a stock. Berkshire Hathaway lists six acquisition criteria in its annual report, including standards that Chairman Buffett and Vice Chairman Munger apply to any company they consider acquiring. Ensure the checklist includes some factors you are reluctant to think deeply about so you can quickly eliminate potentially tempting bad ideas.

➢ Think twice before acting.

At least in terms of investment, Malcolm Gladwell's advocacy for 'thin-slicing' can lead to disaster. Instead, you need to think twice. Knutson states, 'It is important to recognize that the total risk-reward balance is far more influential in driving your behavior than the small probability of gaining a reward. If you realize this, then you should tell yourself, 'I should walk away, play with my children for an hour, and think about it again later.' Making financial decisions under the excitement of enormous potential gains is a bad idea. Calm down; if you don't have children to distract you, take a walk around the block or go to the gym, then reconsider once your excitement has subsided and expectations have cooled down.

Editor/lambor