Why Humans Freak Out So Much: Does AI Freak Out As Well?
Have you ever found yourself suddenly selling all your stocks at a loss, only to regret it later? Or perhaps you've witnessed a market swing that left you feeling anxious and uncertain about what the future holds? You're not alone. This phenomenon is known as a "freak out" in the financial markets, where emotions take over decision-making, leading to irrational behavior.
What Happens When Markets Swing?
When a market experiences a sharp loss, such as a portfolio decline of 5% in just minutes, it can trigger a primal response in humans. The amygdala, a small almond-shaped structure in the brain, fires off, releasing adrenaline and cortisol into the body. Heart rate and blood pressure skyrocket, while rational thinking is left behind. This phenomenon is often referred to as an "amygdala hijack," where emotions take control, and decision-making becomes clouded.
In the past, this reaction was a necessary adaptation for survival. During the Pleistocene era, reacting quickly to potential threats was crucial for human survival. However, today's fast-paced financial markets have made it easier to over-react to even minor setbacks. The same circuitry that once helped humans avoid danger now misfires on everyday market fluctuations.
The Psychology of Loss Aversion
Humans are loss-averse, meaning a $1 loss hurts more than a $1 gain pleases. Prospect theory experiments have shown that people will pay to avoid even small losses, even if the bet is favorable. This bias can lead to herd behavior and social contagion in groups, where emotions are amplified through social media platforms like Twitter and Telegram.
In the cryptocurrency market, this phenomenon has been turbocharged by 24/7 newsfeeds and phone alerts, keeping the threat signal alive and creating an environment of chronic anxiety disorders. Volatility becomes ambient noise, making it difficult for the stress system to reset.
The Physiology of Emotions
When humans experience fear or anxiety, their body responds with a range of physiological symptoms, including increased heart rate, sweating, and tunnel vision. However, AI systems do not possess emotions in the same way humans do. They operate on complex algorithms that process data without feeling any emotional distress.
The Distortion of Decision-Making
Fear can narrow attention and trigger snap judgments, leading to decision distortion. In the financial markets, this can manifest as poorly tuned sell algorithms cascading into a "flash crash" or reward hacking in reinforcement-learning agents, which prioritizes code over intent.
The Importance of Recovery
Recovering from a freak out requires time, coping skills, and sometimes professional help. Humans need to take a step back, reassess their emotions, and regain control over their decision-making. Meanwhile, AI systems can be halted or patched through guardrails such as circuit-breakers and adversarial testing.
Can AI Freak Out Like Humans?
AI systems can behave in ways that resemble mass panic, dumping huge volumes of trades in milliseconds. However, this is not driven by fear but rather the mechanical amplification of their rules. Unlike humans, AI do not experience subjective states like anxiety or dread, which changes physiology and judgment.
Key Differences Between Humans and AI
There are several key differences between human freak-outs and AI reactions:
- Predictability: Human freak-outs are irregular and context-rich, while AI reactions are fully determined by inputs plus code.
- Calm-down mechanisms: Humans can calm down through position sizing, pre-commitment, mindfulness, or stepping away from the screen. AI is kept in check with guardrails such as kill switches, circuit-breakers, and reward-shaping.
Blending Human and AI Judgment
The most robust approach to managing risk involves blending human speed with machine override. Humans set broad risk limits and narrative context, while algorithms execute inside those fences, emotion-free. This hybrid stack allows for the best of both worlds – speed and accuracy from machines, combined with human intuition and judgment.
Takeaways
To avoid freak outs in the financial markets:
- Expect the surge: Design your process to anticipate market fluctuations, knowing that a cool head is unlikely in the moment.
- Respect the machine: Be aware of the potential pitfalls of AI systems and watch for liquidity holes. Have circuit-breakers in place to prevent chaos.
- Blend the two: Use AI for fast, data-heavy tasks and reserve human judgment for regime changes, ethical calls, and meta-decisions about what the objective should be.
By understanding and bounding both human emotions and AI systems, you can unlock a more robust approach to managing risk in the financial markets. Remember, your edge comes from knowing how to navigate both worlds effectively.