Emotion-driven market cycles: How neurobiology explains investment psychology

Introduction

Warren Buffett has a famous saying: “The market is a machine that transfers money from the impatient to the patient.” This statement profoundly reveals the core role of emotions and psychology in market behavior.

Market psychology is the discipline that studies this phenomenon - it explores how the collective emotions of market participants shape financial markets. But the deeper question is: what neurobiological mechanisms are driving these market psychologies?

Science tells us that the human brain is not as rational as we might think, especially when it comes to financial decisions. Emotions, cognitive biases, and psychological processes frequently influence our financial choices, often without our awareness. For example, the amygdala in the brain is responsible for processing fear and triggers the “fight or flight” response. During market crashes, this mechanism may lead us to make impulsive decisions. Conversely, the ventromedial prefrontal cortex assesses rewards and may lead to overconfidence during bull markets. Although these brain mechanisms are crucial for survival, they often cause us to act on instinct rather than rationality in trading and investing.

Dopamine and the Ascending Cycle: Why We Can't Resist FOMO

In a bull market, optimism prevails. Rising prices ignite enthusiasm, and according to neurobiology, this activates the brain's reward system, releasing dopamine—this neurotransmitter is closely related to pleasure and motivation.

Fear of Missing Out (FOMO) is a typical manifestation of this phenomenon. This psychology stems from the operation of the social reward pathways in the brain – we are inherently wired to seek a sense of participation and avoid missing out on opportunities.

Social media platforms (such as X, Reddit, Telegram) have exacerbated the spread of FOMO. These platforms are filled with stories of massive gains, motivating people to buy assets without a full understanding of the risks involved. The most notable examples include Dogecoin, Shiba Inu, and the recent TRUMP coin (official Trump coin TRUMP, current price $5.04, 24-hour drop -0.98%) and MELANIA coin.

The value of these tokens largely stems from speculation and viral trends, rather than fundamentals. Traders often fall into a frenzy, ignoring warning signals—such as overvaluation and unstable growth. Multiple neurobiological processes simultaneously come into play, creating this uncontrollable optimism, which ultimately leads to financial bubbles, at which point asset prices far exceed their true value.

When the bubble bursts, the market enters a downward cycle, triggering a cascade of negative emotions.

Amygdala and Fear: The Psychology in a Down Market

When the market reverses, sentiment shifts from optimism to denial and fear. The amygdala, which processes fear in the brain, takes over, triggering instinctive reactions such as panic selling.

From a neurological perspective, this fear is exacerbated by loss aversion—a cognitive bias that makes us perceive the pain of loss as being twice as severe as the pleasure of equivalent gains.

As prices continue to fall, fear evolves into panic, leading investors to collectively sell off assets, often accompanied by significant losses. This behavior is especially evident in bear markets, such as the sharp correction experienced by Bitcoin (BTC) in 2022, when the price dropped from an all-time high to the $88.17K level (latest data).

The market ultimately stabilizes, as peaks of extreme pessimism often signify the beginning of an accumulation phase—during which prices move sideways. At this time, some investors may cautiously re-enter the market, driven by budding hope and a resurgence of optimism.

The Deep Mechanism of Neural Circuits

Dopamine Pathway and Reward Expectation

Dopamine is mainly synthesized in the substantia nigra and the ventral tegmental area, and it is distributed to various parts of the brain along multiple pathways. The pathway most relevant to market psychology is the mesolimbic pathway—it connects the ventral tegmental area to the limbic system, including the amygdala.

This pathway is crucial for rewards and pleasure. When anticipating financial gains, dopamine is released into this pathway, creating a feedback loop of motivation and satisfaction. This is evident during a bull market, where the brain's dopamine pathways are activated by the expectation of financial profits.

Cognitive Dissonance and Irrational Positions

Cognitive dissonance occurs when traders' beliefs about the market contradict reality. This process involves the prefrontal cortex responsible for higher cognitive functions and the limbic system that is involved again.

Cognitive dissonance may prompt investors to hold onto assets, denying the current situation and hoping for a market rebound—even when all signals point in the opposite direction. This psychological conflict leads to irrational decision-making and financial losses.

Mirror Neurons and Group Behavior

Mirror neurons are distributed in the premotor cortex, supplementary motor area, parietal lobe, and inferior parietal lobule. These neurons are activated when a person performs an action and observes others performing similar actions. Essentially, mirror neurons allow us to indirectly experience the emotions and behaviors of others.

Observing the success of other traders can activate these neurons, leading to imitation—this plays a key role in forming group psychology or herd behavior. In the case of TRUMP Coin and MELANIA Coin (current price $0.11, 24-hour decline -0.71%), social media hype and the participation of political fans reinforce this process.

Case Study: The Psychological Trajectory of TRUMP Coin

Phase 1: Dopamine Activation and Explosive Growth

The explosive growth of TRUMP coin is likely influenced by the brain's reward system. The direct association with the well-known figure Donald Trump and extensive media coverage—these factors may have contributed to the initial surge. Fear of missing out also played an important role.

In this initial phase (known as the Frenzy Phase), optimism and excitement drive prices up. Traders' dopamine pathways are activated, releasing dopamine in anticipation of financial returns, thereby creating a self-reinforcing cycle of excitement and speculation.

Phase 2: Social Reinforcement and Peer Pressure

As mentioned earlier, mirror neurons often play a role in herd behavior. The rapid rise in the price of TRUMP coin is a manifestation of this dynamic—individuals driven by emotions and the perception of others' success may make decisions based on collective feelings rather than independent rational analysis.

In the case of TRUMP coin:

• The Power of Internet Culture: Memes and social media activities create viral hype, inspiring others to follow suit. Mirror neurons may reinforce positive emotions between traders and investors.
• Participation of Politicians and Fans: Trump's political supporters and fans further enhanced the visibility and popularity of the token. Market sentiment spread rapidly through such social interactions.

This fully illustrates how herd behavior dominates the market under the influence of multiple factors—network culture, fan participation, and social influence enhanced by mirror neurons.

Phase Three: Collapse, Panic, and Cognitive Dissonance

Like most tokens, TRUMP coin ultimately experienced severe fluctuations and a price crash. During this phase, traders may experience denial, fear, and anxiety.

Cognitive dissonance may force many people to hold positions despite a downward market, hoping for a quick rebound or believing in a specific price point. The conflict between reality and personal beliefs can lead to irrational decisions and losses.

The amygdala is responsible for the “fight or flight” response, which may exacerbate feelings of fear and anxiety at this stage, leading to panic selling. The emergence of the competitor MELANIA coin may further intensify these emotional reactions, highlighting the influence of external factors on individual investor behavior and even overall market trends.

Key Psychological Traps and Avoidance Strategies

Understanding the psychological and neurobiological mechanisms behind market cycles is of significant value to traders and investors. The following points are crucial:

Observe Emotional Patterns — Identify periods of extreme pessimism or optimism, and observe how these emotions affect market prices.

Understanding Neurobiological Processes — Familiarity with the role of the dopamine pathway, the function of the amygdala, the impact of mirror neurons, and the mechanisms of cognitive dissonance — all these can help you gain a deeper understanding of market psychology.

Avoid Common Pitfalls — Understanding the basics of neurobiology helps to avoid common psychological traps such as cognitive biases, FOMO syndrome, panic selling, and cognitive dissonance, leading to wiser investment decisions.

Maintain Independent Thinking — Be wary of herd mentality and social influences. When making decisions, conduct independent analysis rather than blindly following trends.

Conclusion

The emotions and psychological processes of market participants shape every cycle of the financial markets. Optimism, greed, fear, and panic—these all stem from deep neurobiological processes that directly drive bullish and bearish trends.

Recognizing how these psychological and neurobiological factors manipulate human behavior in the market is crucial for any participant hoping to make more informed decisions. Whether it is the rapid rise and fall of TRUMP coin or the historical price fluctuations of Bitcoin, it clearly demonstrates the key role psychology plays in driving market cycles.

Next time you find yourself driven by FOMO or panic-selling, remember: this is not just a choice issue, but your brain is at odds with you. Recognizing this is the first step towards more rational and profitable investment decisions.

Disclaimer: This article is for educational purposes only. The information in this article does not constitute investment advice or trading recommendations. Please consult a professional advisor before assuming any financial risks. The availability of the products or services mentioned may vary by region.