Instinct and Emotions in Investing

In Sunday’s linkfest, I pointed to an interview with MIT economics professor Andrew Lo. Today, I am privileged to be quoted with the good prof in an article on Investor Psychology:

"Andrew Lo, Professor at MIT, has published an interesting and widely
appreciated work called ‘adaptive market hypothesis’ where he argues that player
behaviour in the markets is influenced by the ability to adapt and evolve to
changing situations. Market behaviour could draw more from Darwin than from Adam

Investors tend to use tried and tested rules of thumb in markets [heuristics] until they
understand the difference in the situation, and then they learn ways to work the
markets. What they do is more about survival instincts, and constant innovation
and evolution, than about cold-blooded mathematics and analytics.

In this game, therefore, the mindset of the player is pitted against the
social structure of the market, and the learning and evolution can never be
uniformly distributed. Also there is no conclusive evidence that one set of
players evolves faster than the others in the market ecosystem.

Others who have actually taken the logic of evolutionary learning to the labs
have found that large mammalian brains like ours are perhaps incapable of
winning in the markets, as our innate survival instincts are pitted against
skill sets needed to win. Barry Ritholtz presents interesting work that argues
that we may simply not be capable of investing rationally, given our genetic
make-up and our learning process.

What does this interesting body of work tell us? We are perhaps better off
remaining closer to our innate preferences and choices until we learn to adapt.
Making investment choices that are ill suited to our basic levels of cognition
and understanding, and more importantly, our ability to cope, can be risky."

Very cool, and very nice company to be included in with!


Instinct, the best investment gauge
Uma Shashikant India Limited, Outlook Money | April 24, 2006

What's been said:

Discussions found on the web:
  1. GRL commented on Apr 27

    Market behaviour could draw more from Darwin than from Adam Smith.

    Actually, Darwin drew more from Adam Smith than the author apparently realizes, since Darwin derived his theory of evolution in the natural world by analogizing to human behavior and culture.

  2. trader75 commented on Apr 28

    Good stuff, but isn’t that last paragraph a bit of a mess?

    “Innate preferences and choices” can be dangerously blind guides if one has not yet “learned to adapt.” Did the author really mean to endorse the fight or flight response?

    Furthermore, making ANY type of choice that is “ill suited to basic levels of cognition and understanding” is probably risky. That observation is practically tautology.

    The intended message of the piece–or at least my interpretation of it–recalls a conversation with an old and grizzled farmer who was part hedger / part speculator (as most of them seem to be).

    “Son,” says he, “the way I see it, tradin’ is a lot like farmin’.”

    “How’s that,” says I.

    “Ya gotta know what the hell yer doin!”

  3. RW commented on Apr 28

    LOL, sho ’nuff Trader75 and as true as it gets: Luck is nice but unlikely to sustain in the absence of understanding.

    GRL, I’ve seen a fair amount of commentary, even from S. J. Gould, that Darwin’s theory arose from his reading of Adam Smith but the assertion doesn’t hold up well. Darwin explicitly analogized to animal husbandry, not economic society, and it was probably (as counseled by his co-discoverer Wallace) his later adoption of Spencer’s “survival of the fittest” description that leads to the erroneous conclusion of economic derivation. It appears that Darwin himself never cared for Spencer’s metaphor and later regretted adopting it (see

    PS: As a semi-interesting factoid, a search of the entire text of Adam Smith’s seminal treatise only extracts one instance of the phrase “invisible hand.” Rather amusing that pundits seem to think this was his central trope which could probably be more closely summarized as “venal greedy merchants (who one would never invite into polite society) do achieve positive results for society even though they obviously have no moral sensibilities or conscience and intend no collective good whatsoever.”

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