Y is for Yawn Effect

The Yawn Effect occurs when you yawn in response to someone else yawning. In fact you can even get your dog to do it (or get coerced into yawning by your pooch). Yawning is contagious, and contagion is an inevitable unconscious consequence of people interacting with each other - and, as usual, when we behave automatically as investors it doesn't make for a good financial outcome.

Example

The Yawn effect is so powerful it's used as a simple test for autism. If a child is suspected of being autistic one check is to yawn at it. If the child yawns back they're not affected. Beware, though, not yawning doesn't mean they are autistic. The best guess is that yawning is a proxy for empathy, although the jury's still out on that one: certainly unconscious mimicry is part of our standard repertoire, and emotional contagion is inferred from this.

This seemingly seamless behavior is replicated in investing where social biases trigger contagious reactions. Herding is the best known of these - the tendency of investors or analysts or forecasters to group together and to behave in a similar fashion. It's certainly not just private investors who do this - investment analysis ran about like simpleminded sheep in the wake of BP's Deepwater Horizon fiasco in the Gulf of Mexico.

What's odd is the way that this behavior seems to be synchronized - frequently herding seems to arise simultaneously across a specific cohort, rather than being transmitted from person to person. It seems that people react in a coordinated fashion to specific types of signal - so just as one person yawning can trigger a whole room of people to act all sleepy, so specific types of trigger can fire off herding.

Causes

Herding is sometimes triggered by social contagion, via self-enhancing transmission bias, but also seems to arise spontaneously, coordinated by a range of behavioral issues - a lack of attention to detail, the disposition effect and also the representative heuristic. In the latter case, for instance, similar beliefs are generated by extrapolation of past performance of attention grabbing stocks.

Also, in the lead up to market crashes herding behavior tends to increase - investors increasingly synchronize their behavior, following each others' trades rather than thinking for themselves. The behavior is self-organized, and is probably triggered by the rise in uncertainty that occurs around these events - we herd together because we're affected by the situation and don't know what to do - so we copy other people. The point being that this is entirely unconscious - someone yawns and we all follow suit, under the right circumstances.

Mitigation

It's difficult to stop yourself yawning if you're one of the people for whom yawning is contagious. I suspect that exactly the same is true of herding and panicking under conditions of uncertainty. However, if you're self-aware you can (just about) stop yourself yawning - and you don't have to follow the herd when the markets get tough. But to manage this you need an investing process and, just as importantly, the willpower to stick to it.

And also: Idiot Noise Traders
Read more: A Liberal Arts Investor's Reading List

The A to Z of Behavioral Bias