A Connecticut couple started with an investment account of several thousand dollars in the 1960s. They put it all in a single stock, PepsiCo (PEP, news, msgs), and then watched as $800 vanished in a market downturn. The experience was so traumatic that the couple dumped Pepsi, and they haven't bought a single share of stock in the 40 years since.

But here's the killer, says a member of the family: "That position, if they had held on to it, would be worth over $3 million today."

This is the sort of episode that gives fear a bad name.

Fear is what makes people bail out of good stocks when they could easily wait out a downturn. It's what makes them feel it's safer to stash their money in a bank account or under the mattress, even when they know it's being nibbled away by inflation. Fight or flight?

It's also what made USA Today run a hapless headline, "Where's the bottom? No end in sight . . ." on Oct. 10, 2002, after the Dow Jones Industrial Average had closed at 7,286. As it happens, though, that was the bottom. Today, the Dow Jones Industrial Average ($INDU) is up more than 70% at 12,580. In other words, Oct. 10, 2002, was a perfect day to buy -- except for fear.

Yet fear is a good thing, in its place. Let's say you're hiking and spot a rattlesnake coiled up just ahead on the trail. The amygdala, the part of your brain that serves as fear central, instantly fires out a signal to make you freeze in your tracks. It happens before you're fully conscious of the threat, and that's what saves you from stepping on the snake. The amygdala is constantly scanning not just for "natural triggers," such as snakes, but also for things that have threatened us in our daily lives, including financial calamities.

Let's say you were a day trader surfing the reality-free momentum of the dot-com boom -- until the day you watched your entire portfolio come crashing down. The intense fear you felt causes you to remember that moment more vividly.

Noradrenaline, one of the fight-or-flight hormones, works on the amygdala as a long-term-memory enhancer, locking in every nasty detail about the thing that frightened you. Your amygdala remembers so it can instantly send out an unconscious alarm at any hint of the same threat. And that kind of learned fear can save your neck: The next time around, over-hyped Internet stocks may not look so thrilling.

But fear is also a tricky emotion. It can blind you to legitimate opportunities. If you over-generalize a threat, it can give you a lifelong phobia about all stocks, as happened to the Pepsi couple. The fear of financial loss literally causes pain.

"When you get burned in a fire, that registers in the pain centers of the brain," says Andrew Lo, a professor of finance and investment at the Massachusetts Institute of Technology. "And when you get burned by losing money, neurologists have demonstrated that that also registers in the pain centers of the brain." Post-traumatic trade syndrome?

One remedy for irrational stock-market fear is the same sort of exposure therapy that psychologists use on people who are afraid of heights, spiders or airplanes. The Pepsi couple might get back in the market with a virtual investing game, where there's no real money at stake.

But play money probably won't help a professional trader who gets gun-shy after a big loss. He needs the real thing to activate the relevant areas of the brain, according to Lo. So a better way for him to rebuild his courage is by starting over at a financial scale where the risks are not so daunting.

By going back into the market and re-exposing yourself to the threat, under safer circumstances, you don't wipe out the memory of the thing that scared you. Instead, you form new memories, to define the threat more precisely. Trying to avoid all danger would just immobilize you. So you learn when it's safe to move forward even in the face of apparent danger.

Scientists have recently discovered that these "courage" memories engage a part of the brain called the ventral medial prefrontal cortex, or vmPFC. And the vmPFC can modulate or override the amygdala's fear response. So courage isn't a product of your brave heart or your big cojones. It comes from your vmPFC. How the brain handles fear

How can this help you the next time an opportunity like Oct. 10, 2002, rolls around? Professional traders increasingly use meditation as a way to keep the mind clear, and new research suggests that over the long term it may make the vmPFC larger and more robust. Traditional relaxation techniques -- breathing deeply and taking a mental step back -- can also help investors recover their precious sense of equanimity in the face of stress.

Some traders use biofeedback devices, which display their physiological responses, like a stock chart, in one corner of a computer screen. They can step back when they are getting into a red zone -- where too much emotion can keep them from spotting the potential for profit or loss.

The idea isn't necessarily to get greedy when everybody else is fearful or vice versa. It's to overcome the excitement and to keep your emotions harnessed to your intelligence, not the other way around.

Published March 3, 2008