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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.
»
- advertisements -
bugs in the brain
Its a trend which is now prevalent sadly in western civilization that instant culture and instant food is the mantra of modernity. Ipad and canned or plastic wrapped food. Junk consumption that you unload on the earth as waste as the product life cycle that society imposes gets shorter and shorter. We're addicts of hyper consumption. This raises many issues which are cultural and linked to education and being able to tell slant from objective fact, reasoned analysis from sales pitch spooled out by 'hidden persuaders' or 'trend specifiers' defining/pushing the current societal wave. The more neutral and passive we are, the easier targets we represent to people with hidden agendas. How do we expose the spin, how do we fight it then? Its the mind set of society that has to change. Under the force of events. Drastic ones. No other way. That is the pessimistic message to humanity. If the greatest democracy can't solve these problems without falling into the 'totalitarian' trap we are in big trouble. We dig our own holes thinking we're digging a bed of flowers, idea sold to us by the spin doctors. We are 'brain washed'. Sad to say but so true.
Fuck. Prof. Wolin of Princeton pointed out long ago that ours is a form of
totalitarianism too.
http://en.wikipedia.org/wiki/Inverted_totalitarianism
ignoring evidence is the essence of the darkages creeping up in us. read what warren buffet has to say about the lemming effect.
http://covert2.wordpress.com
Buffet? Warren Buffet? That bloke owes me weight in .999 silver.