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You'll Lose Money and Buy a Load of Hooey ... Unless You Arm Yourself with Basic Information About How Your Brain Works
Because of bugs in the way our brains work, it is easy to manipulate us.
For example, social proof is the well-known principle stating that many people will believe something if most other people believe it. And see this.
In other words, we have a herd instinct. So if marketers, advertisers or propagandists convince us that most people believe something (even if they actually don't), we'll tend to believe it too.
Psychiatrists and behavioral economists tell us that this is true with investing, as well. Our brains are hardwired to "follow the herd" of investors. Since most investors lose money playing the markets, you don't want to follow the herd.
A study
by Barber and Odeon (Journal of Finance, 2000) shows that an average
household with an account at a large discount brokerage firm
underperforms by an average 15 basis points per month based on the
"efficient market" model. This is based on gross returns before
expenses. The study also found that the average individual investor
would have been better off by not trading.
Indeed, many savvy traders speak of "trading against the dumb money", meaning trading against the majority of people who follow herd instincts and lose money.
Why is the herd so bad at investing? Well, as Paul Farrell wrote last year:
In Mean Markets & Lizard Brains, former
Goldman trader Terry Burnham says our primitive [or "lizard"] brain
was designed to help our ancestors hunt for food, daily survival stuff.
But
“by its very nature, investing requires us to be forward looking, to
anticipate events. Our lizard brains, however, are designed to look
backward. Thus, the lizard brain causes us to be optimistic at market
peaks (after rises) and to be pessimistic at market bottoms (after
falls).” So whether it’s optimism or pessimism, greed or fear, your emotions do your investing, not reasoning and logic—and you can’t trust them.
***
Burnham’s
summary: “We need to precisely restrain our instincts in order to make
money. Unlike neural games of chance, or ancestral problems like
gathering and hunting, financial success means suppressing our ‘gut’ instincts.”
Top investors like Kyle Bass like to quote Charles Mackay on this point:
Men,
it has been well said, think in herds; it will be seen that they go mad
in herds, while they only recover their senses slowly, and one by one.
Speaking of senses, the founder of the field of social psychology showed that the opinions of one's group affect one's own physical sensations. As Wikipedia notes:
In
an otherwise totally dark room, a small dot of light is shown on a
wall, and after a few moments, the dot appears to move. This effect is
entirely inside-the-head, and results from the complete lack of "frame
of reference" for the movement. Three participants enter the dark room,
and watch the light. It appears to move, and the participants are asked
to estimate how far the dot of light moves. These estimates are made
out loud, and with repeated trials, each group of three converges on an
estimate. Some groups converged on a high estimate, some low, and some
in-between. The critical finding is that groups found their own level,
their own "social norm" of perception. This occurred naturally,
without discussion or prompting.
When invited back individually a
week later and tested alone in the dark room, participants replicated
their original groups' estimates. This suggests that the influence of
the group was informational rather than coercive; because they
continued to perceive individually what they had as members of a group,
Sherif concluded that they had internalized their original group's way
of seeing the world. Because the phenomenon of the autokinetic effect
is entirely a product of a person's own perceptual system, this study
is evidence of how the social world pierces the person's skin, and
affects the way they understand their own physical and psychological
sensations.
Paul Farrell gives an example of how the emotion of greed - if not
checked with thought - turns even smart investors into losers:
There was a great article in SmartMoney magazine,
“Outsmarting Your Brain:” Harvard Business School professor Max
Bazerman was speaking to a conference of 75 Wall Street power-players,
guys commanding six-to-seven figure incomes for managing your money.
Max
opened by auctioning off a $100 bill. Simple rules: The highest bidder
gets the $100 bill. And the second highest pays what he bid, but gets
nothing. Forty hands quickly pushed the bidding to $95. Then a couple
presumably rational hot-shots, an institutional money manager and a
pension-fund trustee, broke the $100 barrier, after which both were guaranteed losers.
Imagine
the insanity: Two of America’s financial geniuses caught up in a hotly
contested duel, pushing the bids up, up, up … to $465!
That’s right, the winner bid $465—for a $100 bill!
***
If
you’ve ever doubted that investors are controlled by an irrational rat
brain, the professor adds this scary observation: “I’ve played this
game perhaps 600 times, and I’ve never seen the bidding stop below
$100.” Yikes! It turns out that the best-and-brightest managing the $10
trillion mutual fund industry are just as irrational as the rest of
America’s 95 million average folks who trust them with their money. The
blind are leading the blind. We are all playing the stock market game
like rats and lizards chasing around in a maze for cheese … while
telling ourselves we’re rational.
And as I've previously noted, fear also makes people stupid:
Sociologists
from four major research institutions investigated why so many
Americans believed that Saddam Hussein was behind 9/11, years after it
became obvious that Iraq had nothing to do with 9/11.The researchers found, as described in an article in the journal Sociological Inquiry (and re-printed by Newsweek):
- Many Americans felt an urgent need to seek justification for a war already in progress
- Rather
than search rationally for information that either confirms or
disconfirms a particular belief, people actually seek out information
that confirms what they already believe.
- "For the most part people completely ignore contrary information."
- "The study demonstrates voters' ability to develop elaborate rationalizations based on faulty information"
- People
get deeply attached to their beliefs, and form emotional attachments
that get wrapped up in their personal identity and sense of morality,
irrespective of the facts of the matter.
- "We refer
to this as 'inferred justification, because for these voters, the sheer
fact that we were engaged in war led to a post-hoc search for a
justification for that war.
- "People were basically making up justifications for the fact that we were at war"
- "They
wanted to believe in the link [between 9/11 and Iraq] because it
helped them make sense of a current reality. So voters' ability to
develop elaborate rationalizations based on faulty information, whether
we think that is good or bad for democratic practice, does at least
demonstrate an impressive form of creativity.An article
yesterday in Alternet discussing the Sociological Inquiry article
helps us to understand that the key to people's active participation in
searching for excuses for actions by the big boys is fear:
Subjects
were presented during one-on-one interviews with a newspaper clip of
this Bush quote: "This administration never said that the 9/11 attacks
were orchestrated between Saddam and al-Qaeda."
The Sept. 11 Commission, too, found no such link, the subjects were told.
"Well,
I bet they say that the commission didn't have any proof of it," one
subject responded, "but I guess we still can have our opinions and feel
that way even though they say that."
Reasoned another: "Saddam, I can't judge if he did what he's being accused of, but if Bush thinks he did it, then he did it."
Others declined to engage the information at all. Most
curious to the researchers were the respondents who reasoned that
Saddam must have been connected to Sept. 11, because why else would the
Bush Administration have gone to war in Iraq?
The desire to believe this was more powerful, according to the researchers, than any active campaign to plant the idea.
Such a campaign did exist in the run-up to the war...
He won't credit [politicians spouting misinformation] alone for the phenomenon, though.
"That
kind of puts the idea out there, but what people then do with the idea
... " he said. "Our argument is that people aren't just empty vessels.
You don't just sort of open up their brains and dump false information
in and they regurgitate it. They're actually active processing
cognitive agents"...
The alternate explanation raises queasy questions for the rest of society.
"I
think we'd all like to believe that when people come across
disconfirming evidence, what they tend to do is to update their
opinions," said Andrew Perrin, an associate professor at UNC and another author of the study...
"The
implications for how democracy works are quite profound, there's no
question in my mind about that," Perrin said. "What it means is that we
have to think about the emotional states in which citizens find
themselves that then lead them to reason and deliberate in particular
ways."
Evidence suggests people are more likely to pay attention to facts within certain emotional states and social situations. Some may never change their minds. For others, policy-makers could better identify those states, for example minimizing the fear that often clouds a person's ability to assess facts ...
The Alternet article links to a must-read interview with psychology professor Sheldon Solomon, who explains:
A
large body of evidence shows that momentarily [raising fear of death],
typically by asking people to think about themselves dying,
intensifies people's strivings to protect and bolster aspects of their
worldviews, and to bolster their self-esteem. The most common finding
is that [fear of death] increases positive reactions to those who share
cherished aspects of one's cultural worldview, and negative reactions
toward those who violate cherished cultural values or are merely
different.
***
Investors - as with politicians or Americans in general -
believe that "when [they] come across disconfirming evidence . . . .
they tend to ... update their opinions", but in reality, they cling to
the beliefs they formed during certain heightened emotional states,
such as fear.
And
once people form a belief, it can be almost impossible to get them to
change their beliefs ... even if confronted with contradictory
information.
As NPR noted last July:
New
research suggests that misinformed people rarely change their minds
when presented with the facts — and often become even more attached to
their beliefs.***
A new body of research out of the
University of Michigan suggests ... that we base our opinions on
beliefs and when presented with contradictory facts, we adhere to our
original belief even more strongly.
The
phenomenon is called backfire, and it plays an especially important
role in how we shape and solidify our beliefs on immigration, the
president's place of birth, welfare and other highly partisan issues.
***
It's
threatening to us to admit that things we believe are wrong. And all
of us, liberals and conservatives, you know, have some beliefs that
aren't true, and when we find that out, you know, it's threatening to
our beliefs and ourselves.
***
This isn't a question of
education, necessarily, or sophistication. It's really about, it's
really about preserving that belief that we initially held.
If we hold on to our investing beliefs even when we receive evidence showing that our strategies are wrong, we'll lose money.
The bottom line is that investors,
consumers and citizens have no chance - and will become easy prey to
those who are trying to sell us snake oil - unless we arm ourselves with
a basic understanding of how our brains work.
»
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GW, the last two thirds of your article could have been summed up into:
Most people will avoid/ignore facts that invalidate their previous thinking/decisions/behavior.
A simple example of 'trading' rat brain:
I like the stocks that are going up, so I don't want to sell them (at a profit).
I don't like the stocks that are going down so I'll sell them (booking a loss).
Good to know our minds!
I doubt that's true. Maddow may be a little shrill but she does get her facts straight and backs her stories up with good information and logic. Limbaugh will say anything, no matter how ridiculous, unverified or plain stupid because he knows his listeners won't question it.
The triune brain theory may be a little rusty, but it's still workable. Although neuroanatomists can show that functions of each of the three purported brains are actually distributed throughout the skull mass, the idea of an evolving overlay of reptilian, mammalian and human parts is still helpful to understanding.
The reptilian functions are about automatic unreflective sensory driven impulses, around sex and survival issues: it's cold get warm, hungry so eat, it's Spring so bang bang bang, etc.
The mammalian part added emotion and memory (limbic functions), but without as much reasoning that came later, so we retain a weakness due to the unconscious, automatic, dopamine-seeking reward circuitry of the mammalian brain.
Yeah it helped us evolve (the search for myriad rewards led to greater experience and neural pathway complexity), but it keeps the paradigm of the back of the brain being so much about GO and the front being more about STOP, consider, think it over, balance the priorities as you get it done, etc.
Thus the human overlay in the frontal cortex is more about reasoning, however it is young and runs out of energy, stuffs overload stress into the older parts ie. the limbic system in the back, with which it maintains a real-time communications relay for input based on feeling and memory. When the human brain gets tired, the limbic system with its well of unconscious feeling and traumatic memory can really churn the afflictive emotions, thus confusing identity issues with risk-managed opp-seeking imperatives when dealing directly with market price volatility.
Just knowing about and self-observing the dopamine-seeking reward circuitry in the back brain can certainly help in trading-investing-hedging etc. Dopamine is not bad per se, but we succeed by rewarding the decision trees that are more in our best interest, and less so the ones that offer thoughtless ego hits, or the mindless keeping up with Kardashians, Rockefellers, Jones and other largely fictional creatures...
this was a good article....being right for most people is their essence - their very beings without which they cannot function or exist. if you tie this with greed and arrogance which we all posess in varying degrees then it is easy to see destructiveness of such predilictions....
and yet in some matters, being right is essential to survival and healthy intercourse.
being right is inculcated from the beginning of our existence - by parental discipline, by the school systems, by religion, and god knows what else. our social systems are designed to produce winners and thus being right is a matter of survival or advancement....
it's all unfortunate because their some areas in which being right is not important....people think that those heavily educated money managers are an antidote to foolishness but such is not the case as the experiment exposed class rooms full of walking fucktards. i was a neocon menace for years until i witnessed the treachery and evil of the intelligence agencies and military industrial complex. fortunately being just trumped being right.
when the peaceable kingdom comes, all such rubbish will go by the wayside. maranatha...
bravo gw, bravo.
exert control over biology, win control over everything else.
winning.
OT (sort of)
Gulf spill sickness wrecking lives Nearly a year after the oil disaster began, Gulf Coast residents are sick, and dying from BP's toxic chemicals.http://english.aljazeera.net/indepth/features/2011/03/201138152955897442...
Good article GW, thanks
Public support for the invasion of Iraq was based on the supposed existence of WMDs. It still hasn't been proven that the Administration was lying to drum up support for the war but without the public's belief in WMDs there would have been no war. Ergo, WMDs were necessary. Finding them wasn't.
On another note, I used to question the lone gunman theory of the Kennedy assasination until I visited the Texas Schoolbook Depository, now a museum. Anyone with basic marksmanship skills could have made that shot. Of course, that doesn't mean there wasn't another gunman.
shortly to say,many americans lost faith in God and because that the God trust in their currency became equal,words with no meanings-is my characteristic of the american herd.Now,when the billions suffering from the mass zombonized amerika FED government,why do not you spend some 10sec to make us united and expressing your view on FED,to buy house you never could have on your own,dream so easy sold to the americans,the reason is of thise "bull market" was in crowd believe due many years that at the end stocks going up,it took over 40years to convince youngers while oldies died itself ,but you are who posting here is doomed,because i counted over 50posts and asked to vote for FED existence in my blog:
http://trendybull777.blog.com/2011/02/21/hello-world/
But it was just 3 brave people to respond,which meaning that all of you is sartisfied with current environment and you probably forgot that today Jasmin reolutions based on internet first by FED elite to screw nations,I calling for thoose who wish FED abolished to vote or to leave comments at least,the thing which is world lags today is trust between us!!!
Go and vote,World should not affaid of monster eating into our wealth on everyday basic
This explains Republicans. They seem to be more fearful than Democrats hence their vicseral response to opposing viewpoints.
You must deal with a better class of democrat than I do because I've seen some very nasty and snarky comments when there viewpoints are challenged. It's been shown that liberals in the media will shout racism if they can't control the debate. Of course the conservatives will stand on some "moral" high ground. I think it is safe to say that by now most republicans and most democrats have dug in their heels concerning their views of the world and both refuse to be swayed by opposing viewpoints no matter if their own viewpoints are proven to be flawed. Talking to either side is like banging your head into a brick wall. You can no more move Maddows off her views as you could Rush. I happen to find both annoying as hell.
Rush is at least funny sometimes even when he is being a douche.
Maddow is never more funny than she is woman ...
She's a woman?
"These are my people. Americans."
http://www.youtube.com/watch?v=6Eib2di9bq4
WW: I was going to answer you here but put it in other context (maybe yours, I'm not presuming):
#1034338
My O/U on any response to this? http://www.youtube.com/watch?v=K8E_zMLCRNg
- Ned
lolwhatever
+ 1,000
+1
I was thinking this explains the deplorable actions of NPR.
I am as much conservative as I am liberal, and many of my favorite politicans, writers and thinkers are conservative.
Scientifically:
http://www.rawstory.com/rs/2010/12/28/conservatives-fear-center-brain/
http://www.wired.com/wiredscience/2008/09/fearmongering-h/
"We"? Most humans, yes.
"The majority of" does not mean "We". This abusive generalization is part of the little details that make science news reported in newspapers so cocky, authoritarian and despisable.
Yes, most people are irrational, conformist and dumb, but that's not breaking news. This fact is known since the dawn of times by the elites and serious scientists (not the sociologist/gender studies crap).
George Washington is progressing, though. He's beginning to understand why Americans seem to love their current situation, and why they'll probably elect another Obama in 2012.
Michelle?
the reptilian part of my brain likes food, sex and shiny things.
no alcohol?
How do you get by all day?
Nice Article,
There are entire books dedicated to the Psychology of Trading.
Good Luck all...
BS....traders are like Gump, MA traders, momo traders, spike traders, hft traders, dip traders, spread traders, write option traders, deal traders value traders, growth traders...so on and so forth...those who try to combine stratigies often fuck up... scampi shrimp, boiled shrimp, popcorn shrimp....
jumbo shrimp
military intelligence
Turtles
- Ned
{but never pulled pork!}
+1
So says Dr. Elder and many other successful traders. Keep it simple, stupid.
"The study also found that the average individual investor would have been better off by not trading.!" from personal experience I can definitely confirm that LOL
All that means is that the market is a "sold to you" scam and that an individual can't make any money in it no matter how hard they try or "go against the herd." It's a rigged game.
The "no blood for oil" crowd had their facts correct, but the emotional content wrong. "Vengeance on the guilty only" would have been a better chant. Those keen to hit Iraq correctly anticipated that the purported al Qaeda connection would allow them to manipulate public opinion.
As it happens, among Iraq, Saudi Arabia and Iran the U.S. leadership believes it needs the oil production of one of the three online. Saudi has long been at risk of going offline like Libya just did, and Iran has long been in the hands of extremists and hence essentially offline due to sanctions that prevent the efficient exploitation of its considerable reserves.
As a geostrategic matter, holding one also gives implicit leverage against the other two (or at the very least, lessens their leverage).
So we were lied to, on purpose, in order to do something the Washington insiders believed needed doing. A more important question than why the public was misled is why the leadership believes as it does, when any number of technological choices could lessen the dependence on any petroleum, let alone mideast petroleum.
It's possible that climate change orthodoxy is a whole new set of lies, intended to sell an expensive set of solutions to the aforementioned problem, which will be solved for an ostensible set of emotionally salable reasons that is very different from the true set of reasons known mainly to the people working behind the scenes.
Never let a good crisis go to waste.
People have a basic need for reassurance. Unfortunately, in many cases this means they blatantly ignore the reality that's right in front of them. This in turn means that the corporate MSM keeps them under control and gets rich off them.
As to why millions of progressives don't band together, it's partly a matter of egos. On the one hand, nobody can agree on who the "leader" is. On the other, nobody wants to act until someone else does it first, and there's no apparent danger.
It's the same with religion - i mean who would come up with that crap on their own if it wasn't presented to them by a herd of sheeple. It is those who benefit from the lie that, of course, have the greatest vested interest in perpetuating the status quo - bishops etc... or bankster oligarchs who try to convince us that if all we selfish, fearful people are left to our own, then enlightened self interest will magically make it better for everyone. In this case, it is the bishops of "capitalism" that suggest that unregulated derivatives trading etc will benefit all - . In reality all these charlatans and their corrupt institutional cronies just want to shear the flocks, sodomise the choirboys and keep us stupid and laugh all the way (back) to the bank. Honestly - There is a pie in the sky - trust me.
Mendocracy - a society ruled by liars
Good article - i need to tame that beast too - tried to be out of commodities monday morn and STILL found myself chasing that dip this morning....
The old adage, don't believe what you read and only half of what you see, plays an important role.
The degree of truth within facts has to determined. Which is a big pain in the ass and makes most of us dizzy as shit. Most just give up and look for the moment that satisfies the immediate senses.
As far as traders and investors. How good are we as farmers, if we don't know anything about it? Everybody thinks they are smart, so take shortcuts in critical thinking. I know I do, and often pay for it. But, when we are right, it further justifies repetition of the stupid behavior and thought process.
HOW hard should investing or trading be? It either goes up, goes down or stays the same. Pick your favorite horse and cheer it on! LOL
Shun the Fluoride.....
Behavioral Economics--I've liked Jason Zweig the younger: "Your Money and Your Brain", e.g.:
http://www.abebooks.com/servlet/SearchResults?an=zweig&sts=t&tn=your+mon...
and a list.
http://icsihealthcareblog.wordpress.com/2010/01/29/kent-bottles-my-top-t...
- Ned
{given today's further resignation, I'm amused at the citation of NPR as a reasonable source for much of anything.}
And somewhere, Juan Williams smiles.
GW should have collaborated with Cognitive Dissonance on this post--would have been twice in length and no more useful to those of us without a Phd in psychology
Loool, you're wrong but you're funny. TY!
The reptilian portion of the brain accurately describes the status quo thinking going on around the world. What's their crack? Any sophistry that wrongly explains things.
Click forward, and into the mammallian portion.
It's always funny that dipshits believed the guy that was going to 'keep us safe', was really the guy that the 'unsafe' happened. We even have the name of the PDB. I witnessed a huge part of the lunacy first hand when the 3rd presidential debate in 2004 was @ ASU (and all the lamestream was set up with their tv broadcasts for a couple of days). The idiocy spewing forth was unbelievable. Sadly, it's only gotten worse, and we're getting much better information (with obvious real life examples) these days.
I've also been in class when that '100 dollar bill' game was played. I stopped as soon as there was no profit in it, or a measely one. I.E. ~98-99. Yes, and the dipshits continued pushing it up. I'm sure they ended up making lots of fiat pushing crap somewhere.
Biu gold, oil (USO), palladium (PALL) and silver and you are set.
are you trying to be the CogDis for J6P?
you did say it in about half the pages he does, though not with the same elegance and depth.
"century of self" episode: engineering consent
http://www.youtube.com/watch?v=H9RfanOEpA0
Good article. The shit they feed us called food is a major culprit in alterating our brain chemistry. Case in point, the GMO's in the corn they feed the cattle that the majority of us eat have disproportionate levels of fatty acids. www.naturalnews.com has a plethra of info on food if anyone is interested.
wow really, junk? ok can I get fries with that?
Those junkers must have been drinking out of their BPA plastic sippie cups.
You got drive-by junked while waiting for your order.
Constant McViolence on GW's posts.
We are Predictably Irrational...very cool presentation
http://www.youtube.com/watch?v=JhjUJTw2i1M&feature=related