Example
The psychologist Bruce Hood uses a sweater to demonstrate negativity bias. He can get anyone to wear his sweater - until he tells them that it used to belong to a serial killer. Whereupon no one will go near the thing despite the fact that, as far as we know, a woolly pullover is not a disease vector for serial-killer-itis.
In similar fashion investors pulled billions of dollars out of the market in 2008, just as it was starting its long crawl out of the abyss. People were much more focused on the damage further falls could do to their wealth than they were on the positive potential or, come to that, a more nuanced analysis of valuations or history. Negativity is psychologically contagious.
Causes
In similar fashion investors pulled billions of dollars out of the market in 2008, just as it was starting its long crawl out of the abyss. People were much more focused on the damage further falls could do to their wealth than they were on the positive potential or, come to that, a more nuanced analysis of valuations or history. Negativity is psychologically contagious.
Causes
In evolutionary terms it's pretty obvious why we'd tend to favor the negative. If we're approached by two people, one of them a known friend and the other a stranger we'd be foolish to concentrate on the friend. We know they're not likely to kill us. Similarly we have an in-built negative reaction from food poisoning which puts us off the food we vomit up. Today, however, that food often isn't the cause of the illness but evolutionarily speaking avoiding it made sense. Eat berries, throw up, don't repeat.
Mitigation
You can't really help but be affected by negativity bias, and running for cover when markets go wrong is a natural reaction. Experience helps, but is an expensive teaching aid. Reading widely (try the Mlodinow and Fisher and (ahem) Richards books in the list linked below) can help, if you're willing to let the long-term trends of the past be your guide. After all, the person who forgets history is doomed to repeat it.
Negativity bias added to The Big List of Behavioral Biases.
Negativity bias added to The Big List of Behavioral Biases.
It would have been very silly to start investing in the S & P 500 in 2008 as it was still literally crashing until November of that year. It wasn't until 2009 that it began to recover. Had you stayed invested throughout 2008 you would indeed have suffered more and more damage.
ReplyDeleteI know because I was there! Pulled out in November 2007 and stayed out until March 2009 and doubled my money in 2.5 years, if that's what negativity bias does for you then I'll have a ton of it please.
The salient thing about the crash was that there was lot's of effort going on and little progress being made, then the market went through big swings day to day (always a good warning) whilst trending sideways, at that stage (November 2007) I bailed on grounds of full valuations but lots of money circulating with indices going sideways instead of up. Clearly, something was wrong although I had no idea about the impending CDO/CLO disaster.
By late 2008 everything looked too cheap and I considered re-entering but my "negativity bias" saved me as I decided to wait for a signal from the market, it came 4 months later when there was a sudden surge followed by another a week later and back in I went.