100 Ways To Leave Your Lucre

Irrationality, The Enemy Within, by Stuart Sutherland

For those of us interested in how people manage to behave oddly in the face of anything to do with finance, these recent years have been good, as a range of intelligent books have been published on the topic. From Freakonomics and Predictably Irrational to The Undercover Economist and Nudge, plus a whole host of imitative single word follow-ons, we’ve been treated to real economists demonstrating a hitherto unforeseen talent for communicating with the unwashed masses. Nonetheless, despite this, there is still no better introduction to the subject of behavioral psychology than Irrationality, by Stuart Sutherland, even though it originally dates from 1992. 

Unsurpisingly, although the world has moved on, people haven’t; and the mistakes they made twenty years ago they still make today. We are still the enemy within.

Read Full Post >>

Blood on the Street

“The time to buy is when there’s blood in the streets”, Nathan Rothschild (attributed).

Micro or Macro?

Normally stock picking investors are interested in the microeconomics of firms; their earnings power, competitive advantage and so on. These factors will, over lengthy periods, determine whether companies outperform their peers or not. In recent years, though, a curious thing has happened: these self-same investors have become more concerned with macroeconomics; the trends and decision making processes within the overall economy.

It appears that investors no longer worry much about the fundamentals of investments or even the wiggly predictions of charts, because they have a much more basic way of assessing the likely trajectory of stocks: political analysis. And the result of this may be that we will have blood running in the streets. Again.

Read Full Post >>

Crash 2012: The Sunspots Are Coming …

Spurious Predictions

Next year (or, more probably, the year after) will, scientists predict, be the peak of the current sunspot cycle, when the Earth will be blasted by electromagnetic waves emanating from the Sun, disrupting communications networks, destabilising power grids and causing an almighty market crash as panicked investors head for the hills.  Although presumably they'll leave their battery powered cars at home.

Of course, if that turns out to be true I’ll claim I’m prescient and if it doesn’t, well, then it’s a deft attempt at irony. The effects of sunspots, however, are very real indeed and, for reasons we shall now analyse, the worst affected people appear to be economists.

Read Full Post >>

HONTI #4: Disconfirm, Disconfirm, Disconfirm

Rule #4: Look for evidence that you're wrong, not that you're right.

Be Prepared to Change Your Mind

"When the facts change, I change my mind. What do you do, sir?"; John Maynard Keynes (allegedly: see Quote Investigator)

Once you've done your careful research, or blindfolded a bemused ape and got it to stick a pin in a list of stocks, and bought into some corporation or another, you immediately become exposed to one of the nastiest behavioral biases on the block: confirmation bias. You will, whether you realise it or not, start to favour information that supports your decision and to discount that which doesn't.

Ever get a nice warm feeling when someone tips¹ a stock you own?  That's confirmation bias in action and if you let it blindside you it'll take you down, along with your portfolio.

Read Full Post >>

Mental Models, Arrayed on Charlie Munger’s Latticework

Old Ideas, New Context

One of the origins of this e-rag was the idea that investors might be able to learn something from the vast array of information in the world not commonly presented to them in a useful form. Much of this information isn’t about investing, although it can often be usefully related to it.

This idea, of course, isn't new. It’s nothing more than a slightly updated take on an idea which will never get old: Charlie Munger’s concept of arraying knowledge on a latticework of mental models. However, it’s one thing to produce individual ideas, as we do here, it’s quite another to put them all together and make them usable.

Read Full Post >>

Are Traders Dumber than Drooling Dogs?

Salivating Spaniels

Given the ebb and flow of investor sentiment, often for no other apparent reason than the ring of the opening and closing bells of the market, it’s terribly tempting to compare traders to the salivating dogs from Pavlov’s famous experiment.  The dogs, of course, were trained to salivate at the ring of a bell in the expectation of a good meal.

Naturally, this would be demeaning, a gross insult to the intelligence of our canine friends.  Because it turns out that there’s quite a lot of good evidence that humans investors are, despite their superior intellectual capabilities, dumber than drooling dogs.

Read Full Post >>

Robert Cialdini and the Weapons of Influence

“Well here, again, Cialdini does a magnificent job at this, and you’re all going to be given a copy of Cialdini’s book. And if you have half as much sense as I think you do, you will immediately order copies for all of your children and several of your friends. You will never make a better investment.”; Charlie Munger on The Psychology of Human Misjudgement.

A World Too Complex

One of the recurring themes in behavioral economics is the concept of bounded rationality: the idea that we’re perfectly rational up to the point at which our limited brainpower stops out. Cialdini’s Influence turns this idea on its head, and argues that it’s our brainpower that’s created a world that’s too complex for us to understand: and that the result of this is that we take mental shortcuts, which then open us up to exploitation at the hands of any unscrupulous third-party. Which is pretty much everyone, these days.

We'd argue that these weaknesses are exposed directly in stockmarket investing when we're not so much fooled by other people as dumbfounded by our own brains.  Influence is not about investing, but about psychology: which makes it essential reading for everyone, but especially investors.

Read Full Post >>